Are you just dying to pay the taxman?

As the Chancellor tightens his grip on inheritance tax, simple steps can slash your liability. By Chiara Cavaglieri and Julian Knight

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The brief period when both main political parties were fighting to show which of them would cut inheritance tax (IHT) the most is gone, at least for the time being. Labour now sees the Tories' plan to raise the IHT allowance to £1m as an Achilles heel, as this is essentially giving a tax break to the wealthy at a time when public finances are a mess. The only surprise about Alistair Darling's announcement in last week's pre-Budget report – that the IHT threshold will be frozen at £325,000, reneging on a promise to raise it to £350,000 – was that the Chancellor didn't go further and roll back previous reforms which had seen married couples and civil partners allowed to combine their IHT allowances.

Inheritance tax currently claims 40 per cent of assets worth more than £325,000 upon death. On an estate worth £500,000, this equates to an IHT liability of £70,000. One of the biggest criticisms is that this nil-rate threshold has failed quite spectacularly to keep up with increasing property prices.

"Since 1997, the IHT starting point has increased by only 51 per cent compared with an increase in house prices of over 130 per cent for the UK as a whole," says David Kilshaw from accountancy firm KPMG.

As a further clampdown, but only affecting a minority of taxpayers, legislation will be introduced next year to close two complex tax-avoidance schemes. "These closures have been designed specifically to attack non-standard inheritance-tax planning. They are closing down loopholes used in complex planning which involve large amounts of money," says Danny Cox, from independent financial adviser (IFA) Hargreaves Lansdown.

With the future direction of inheritance tax uncertain – with much seemingly depending on the next election – it's up to everyone with a potentially large estate to minimise the tax hit. Fortunately, there are fairly simple steps you can take to slash liability. In fact, according to research from financial advice website Unbiased.co.uk, Britons could avoid up to £2bn a year in IHT just by careful planning.

First, it's important to note that Mr Darling confirmed that he will still allow couples to combine their IHT allowances. Under changes introduced in 2007, an unused IHT allowance is transferable between married couples and civil partners. If your spouse dies, their allowance is transferred to you. So, upon your death, the nil rate band is effectively double the individual rate.

When it comes to reducing liability, gifts between husbands and wives are always free of IHT, but you can also give several thousand pounds away every year without it counting towards your estate. Annual and occasional gift allowances mean that you can give up to £3,000 in one tax year. This allowance can also be carried forward for one year only, so if you didn't use it in one year, the following year's allowance increases to £6,000. Gifts from your excess income are also not liable for IHT as long as they are considered to be part of your "normal expenditure". These gifts must be habitual, the intention being that you make gifts annually, and they must not affect your standard of living.

"This can be put to good use in the form of regular annual savings for your children. For instance you might pay £3,000 a year into individual saving accounts (ISAs) or stakeholder pensions for your children, and if you have investments accumulating income, you could arrange for that income to be paid out into plans for your children as well," says Robin Keyte, from IFA Towers of Taunton.

Small gifts of no more than £250 to any number of people in one year are also permitted, as well as wedding gifts of up to £5,000 if given to your child, £2,500 for other relatives and £1,000 for anyone else. Any donations to a charity, national body such as a museum or political party are also exempt.

For larger gifts, trusts set up for children and grandchildren play a key role in IHT planning. Money paid into a trust that can only be accessed when the beneficiary reaches 18 is exempt from tax, but only if the gift was given at least seven years before you pass away. You should also write your life-insurance policy into trust so the money goes to your beneficiaries rather than through your estate when you die. Setting up a trust can be complicated so do seek professional help from an IFA.

Knowing when to give your assets away is absolutely crucial. Donations outside the annual gift allowances are treated as potentially exempt transfers (PETs), which means that they remain within your estate if you do not survive seven years. However, the value of any gift is measured at the point of passing it on, not when you die. Therefore, if you were to give away some of your assets now, if they grow later down the line, those improvements will not be counted towards your eventual IHT liability. You're still giving away the same proportion of your estate, but at a lower value than you might hope it will reach when you die.

This can be risky, however, as once it's been given away, there's no turning back. Unless you're sure that your standard of living won't be affected by handing over your assets, it's not worth the risk simply to reduce IHT liability.

"The advantage of a PET is that the growth in its value is immediately outside of the estate. However, once gifted, this is no longer your money or asset and you cannot derive any benefit from this," says Mr Cox.

More complicated inheritance tax planning might involve Enterprise Investment Schemes (EISs), in which you can invest in fledgling, high-risk firms. These investments qualify for 20 per cent tax relief on the sum invested, up to £500,000 per year, as well as 100 per cent IHT relief after two years.

"They may not be the first most obvious solution," says Kevin Tooze, from IFA Equity Partners, "but once you have exhausted gifting, life cover and specialist trusts they may have a significant role to play in your beneficiaries' future wealth."

Plan ahead and save a fortune

- An annual IHT exemption allows you to give away £3,000 in each tax year, either as a single gift or as several gifts.

- If you do not use up this £3,000 exemption in one year you can carry it forward, for one year only.

- Smaller gifts of up to £250, to as many people as you like, are also exempt – designed to cater for birthday and Christmas presents.

- Wedding gifts of up to £5,000 from parents, £2,500 from other relatives and £1,000 from anyone else are permitted.

- Gifts to charity, political parties and bodies such as national museums and universities are exempt, no matter how large.

- Outside these allowances, gifts made more than seven years before your death are not liable for IHT.

- Ensure you use up your full IHT allowance as efficiently as possible.

- You can give away money from your surplus income without paying IHT, as long as it does not affect your standard of living and forms part of your regular spending.

- Have your life insurance policy written into trust so that it is not subject to inheritance tax.