One day, all this could be yours: a home and a huge claim for inheritance tax

Melanie Bien shows how to limit the damage as rising house prices put more and more estates at the Revenue's mercy
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The Independent Online

Discovering that your home has increased significantly in value is welcome news if you are trying to sell it. But it's not so desirable if that rise makes your estate liable for inheritance tax (IHT).

Discovering that your home has increased significantly in value is welcome news if you are trying to sell it. But it's not so desirable if that rise makes your estate liable for inheritance tax (IHT).

Price inflation in bricks and mortar means that IHT is no longer only for the super-rich. The first £263,000 of everything you leave behind - including property, savings and investments - is tax-free; but your beneficiaries will pay tax at 40 per cent on any amount over that threshold. IHT is payable before your beneficiaries can gain probate, although if it is due on land, property or shares in an unquoted family firm, it can be paid in 10 annual instalments.

The Inland Revenue expects 34,000 estates to be liable for IHT in 2004-05, which isn't surprising when you consider that Leeds & Holbeck building society discovered that 60 per cent of those over the age of 50 have not sought advice about IHT planning.

The Institute for Public Policy Research (IPPR) is calling for the system to be made fairer. It believes the way to do this is via a banding system, similar to income tax, with a base rate of 22 per cent and higher bands of 40 and 50 per cent. Under this proposal, the IPPR argues, 87 per cent of estates would pay less tax but the new system would still raise an extra £147m.

"A fairer IHT would see the wealthy, who are comfortably over the threshold, pay more, while the vast majority of families that are currently taxed would pay less," says IPPR researcher Dominic Maxwell.

But whether or not the Government reforms IHT, there are ways in which individuals can reduce their liability. Below, we run through the main options available to you.

Write a will

Die intestate - without writing a will - and you could cause confusion and distress, and leave a hefty IHT bill. If you haven't written a will, do so immediately. Or if it's out of date - perhaps you've got married again or had children since you wrote it - make another (destroying the old one). This will ensure that your assets are distributed after your death according to your wishes, and you can also include provisions to mitigate IHT.

You don't have to use a solicitor: you can write your own will. However, if your financial affairs are more complicated, it may be worth forking out for legal advice. This shouldn't cost any more than £50.

Tie the knot

Assets transferred between married partners are not liable for IHT as long as both live in the UK. So if you jointly own a property, and you die, your spouse won't have to sell up and move somewhere smaller in order to pay the IHT bill.

"If you are married, your assets pass to your spouse on your death and IHT is due only when the second partner dies," says Philippa Gee at independent financial adviser (IFA) Torquil Clark. "But if you are not married, IHT is payable on the first death as well as the second."

Each person has their own nil-rate band for IHT, so a couple's estate could be worth up to £526,000 before the tax is payable, as long as both nil-rate bands are used and wills are in place to achieve this.

Don't put off IHT planning until a spouse dies. "If you have a lot of spare cash and think that the person who survives you won't need it, the first spouse to die could leave up to £263,000 to their children [so keeping to the nil-rate band]," says Jacqueline Thomson, trust manager at Smith & William- son, the professional and financial services group. "They can also make sure their nil-rate band is in a discretionary trust so that it doesn't count as part of the survivor's estate when they die [and then the heirs benefit from two nil-rate bands or £526,000]. But this trust needs to be properly worded."

It is possible to leave your share in the family home in this way, so it is not liable for IHT when the surviving spouse dies.

Give generously

Each year you can give away up to £3,000 each to individuals, free of IHT. And don't forget modest gifts from income: these are handouts the Revenue describes as "normal" or "habitual" and leave sufficient income for the donor to maintain their standard of living.

If you have enough spare income, you can pay regular amounts to a child, for example.

If your children get married, you can also give them £5,000, while other relatives can pass on up to £2,500 free of IHT.

Live for seven years

You can give away an unlimited amount, but if you die within seven years of doing so, the tax assessment is based on the date of that gift and the date of death. A sliding scale of tax rates is used if the gift is in excess of the nil-rate band, so the longer the period between the two dates, the smaller the tax bill. This is known as a "potentially exempt transfer".

Put it in trust

Trusts aren't just for those who are seriously loaded: they are a useful way of mitigating your IHT bill if you are of more modest means. A trust enables you to transfer assets out of your estate while still maintaining a degree of control over them.

There are two main types used for IHT planning:

¿ A discretionary trust gives the trustee absolute discretion over who benefits from the assets from among a number of beneficiaries specified by the person setting up the trust. But gifts into these vehicles are taxable at 20 per cent if they exceed your nil-rate band.

¿ Accumulation or maintenance trusts are discretionary trusts for children. The donor doesn't have to specify what each child will receive; the trustees decide according to need. Once the children are 25, they have the right to income from the trust.

Consider equity release

If you don't have liquid capital to give away or put in trust, equity release enables you to unlock some cash from the value of your property to use in IHT planning. Under these schemes, you can generate a lump sum or regular income in return for allowing the lender to take ownership of a portion of your home. This loan is repaid with interest out of the estate on your death, reducing your heirs' liability for IHT.

Equity release plans can be expensive, however, so think carefully before going down this route and consult an independent financial adviser.

Buy life assurance

If you anticipate a large IHT liability, you could take out a life assurance policy to cover the costs when you die. But ensure it's written in trust so that your spouse and children don't have to pay IHT on it.

Seek professional advice

Tax regulations can be complicated. It is worth seeking advice from a tax specialist on how to mitigate your IHT bill.


Penny Barkham, 57, has two children, both in their 20s. She recently set up trusts on their behalf, after taking advice from the independent financial adviser Norwich & Peterborough.

Ms Barkham, a care home manager from Ashford in Kent, was keen to try to minimise her inheritance tax liability. She also wanted to help her children out financially in the future. Another motivating factor was the IHT bill she and her family were left to pay on her father's estate after he died in 2000.

"My father always said he didn't have a big enough estate to incur inheritance tax, but when he died we discovered that he was £50,000 over the threshold," she says. "I am glad he never knew that this was the case, as it would have caused him a lot of grief."

After paying tax on her father's estate and suffering a health scare herself, Ms Barkham decided to put her financial affairs in order.

"I am 57 now, so it's a good time to plan for the future," she says. "I have set up two trusts so far and have further plans to minimise my IHT liability when the final part of my divorce settlement comes through."

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