Death and taxes, famously the only certainties in this world, according to Benjamin Frank-lin, can come as a particularly heavy blow when they strike together.
Inheritance tax (IHT) or death duties used to concern only the very rich. But soaring property prices have pushed millions of "ordinary" people over the £255,000 IHT threshold. Figures from the Consumers' Association show a 55 per cent rise in the number of estates caught by the tax in the last five years.
If a person leaves more than £255,000 on their death, their heirs must pay 40 per cent tax on the excess - a sizeable hole in any inheritance. To make matters worse, many people are blissfully unaware of this trap; 77 per cent of those interviewed in a survey for the Alliance & Leicester bank had no idea at what point their heirs would have to pay IHT. This means they are missing out on the chance to prevent the Inland Revenue from helping itself to a generous slice of the savings they plan to bequeath.
Before approaching a tax adviser or accountant for advice, you should draw up a will. This is the only way of ensuring your loved ones and your favourite charities benefit from your estate according to your wishes. Many people are surprised at how much they are worth once they have taken into account their savings, investments, pension, house and car.
You might find it pays to be generous. John Whiting, tax partner at accountants PricewaterhouseCoopers (PwC), says: "If you're worth a reasonable amount, think about giving away your money during your life because of the tax efficiency."
You can hand out money to friends and family and escape paying IHT on it as long as you don't break the Revenue's "lifetime gift" rules. If you make a gift of any size - cash, car or property - and live for seven years afterwards, it will not be liable for IHT. But beware of giving, say, a holiday cottage to your children and then continuing to use it. This counts as a gift with strings attached, and unless you pay your children for the time you spend there, it could fall back inside the IHT net, warns Mr Whiting.
As much as £3,000 can be handed over free of IHT in any tax year, perhaps as sizeable cash gifts to friends, and up to £250 given to any number of people. Bequests to charities, donations to political parties, and shares held for two years on the Alternative Investment Market are also exempt from IHT. Wedding gifts escape the net, too, up to a certain limit: parents can give newlyweds a maximum of £5,000, grandparents can give £2,500, and others £1,000.
Upon the death of a spouse, assets pass free of IHT, and it's clear that close family ties can help cut your tax liability. "Whatever you do, it must stack up with the family," adds Mr Whiting. "It's not so much tax planning as family planning."
This advice applies in particular when it comes to reducing IHT liability on your property, a complicated process likely to require the help of a solicitor or tax adviser. A number of schemes exist that enable you to alter the structure of your home ownership for tax purposes (see right). These include making married couples "tenants in common" in the family home; setting up a "will trust" to turn a home's equity into debt; and taking out a complex "home loan" by which parents sell their house to a trust that becomes, ultimately, a transferable debt. Equity release has also grown in popularity as a way to cut IHT bills, although consumer bodies advise that such schemes should be approached with great caution.
While strategies of this sort are all legal, the Revenue keeps a close eye on them, says Chris Shepard, a senior trust manager at accountants Smith & Williamson. "While it may work at the moment, the taxman can always change things," he warns.
Setting up a conventional trust is a good way of controlling what happens to your estate after your death but it won't protect your heirs from IHT. PwC's Mr Whiting gives a typical example of its use: "For grandchildren, it could pay out income for school fees and then be available [as a lump sum] when they reach 25."
To keep track of your likely IHT bill, review your assets every few years. The last three years of plummeting stock markets have ravaged many investments, reducing the value of estates and thus their IHT liability - although that is likely to be of little consolation to beneficiaries.
For professional help on IHT planning, contact the Chartered Institute of Taxation for a list of advisers in your area. Call 020 7235 9381 or visit www.tax.org.uk
Keep the tax wolf from the door of your family home
Before IHT planning
Assuming a house is an individual's only asset, a property worth £500,000 passes from a husband to a wife (or vice versa) under normal joint tenancy arrangements, and then to any children of the marriage when the surviving parent dies. The IHT bill on the death of the second spouse will be £98,000 (£500,000 - £255,000 x 40 per cent).
After IHT planning
The joint tenancy is severed and the couple now own the £500,000 property as "tenants in common". The first spouse to die can then pass his or her half share of the property to the children, leaving the bequest within the £255,000 IHT threshold. When the surviving spouse dies, the remaining half can pass to the children without any IHT to pay.Reuse content