Beginner's Guide To: Inheritance tax

This week's pre-Budget report won't go down as one of the most enthralling, but one point worth picking up on is the freeze on Inheritance tax (IHT). This tax may hit some of us in the future, but there is some confusion as to what it is and how it may affect us. We take a look.

What is it?

IHT is levied on a person's estate after death. The first £325,000 (£650,000 for couples) is tax-free but if the value of your assets is more than that, tax will be levied at 40 per cent.

An increasing number of people have been pushed into the IHT net because of higher property price, and although the Government had said the IHT threshold would rise to £350,000 in April 2010 , the Chancellor has now back-tracked on this and will keep it at its present level. With house prices having fallen he said there was no need to increase the threshold. Critics disagree saying the current threshold would be significantly higher if it had risen in line with house prices.

Are there any ways to reduce your IHT liability?

Anything left to a spouse or civil partner is exempt from IHT. Bear in mind that the value of those assets will form part of their estate on death. If the first person's IHT allowance isn't used, the surviving spouse will have a double allowance.

There are also certain gift allowances that can reduce the value of your estate. Any assets you give away will fall out of your estate for IHT purposes after seven years – they are known as 'potentially exempt transfers'.

Some cash gifts fall out of your estate immediately: parents can give a wedding gift of up to £5,000, while grandparents can give up to £2,500. Wedding gifts to anyone else are exempt from IHT up to £1,000.

You can also give away up to £3,000 a year, and individual gifts of up to £250 to any number of recipients can be made each year. You can also give money to charities, museums and the main political parties.