Life after death for all your assets

Neil Baker looks at the strategies that help you avoid inheritance tax
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Nobody likes to pay tax if they can help it. But inheritance tax, which is technically voluntary, raises pounds 1.5bn each year for the Inland Revenue. It can be easily avoided, so why does anyone pay it?

The good news is that 96 per cent of deceased persons' estates do not pay any inheritance tax (IHT). The tax is levied at 40 per cent of the total value of your assets when you die, above a threshold of pounds 200,000. If your assets are worth less than that, there is no tax to pay. Even if you are a multi-millionaire, there is no tax to pay if all your assets are left to your spouse - as long as you are both treated as living in the UK by the Inland Revenue. Any money you leave to a charity also escapes IHT.

But if after paying your spouse and your favourite charities, the executor of your estate is left withmore than pounds 200,000, the Inland Revenue will take 40 per cent of anything remaining. The only other deductible items are any bills you owed when you died and the cost of your funeral.

You can reduce your potential IHT liability by giving away assets before you die. But there is a limit to what you can do.

Some gifts are only exempt if you live for seven years after making them. The idea is to stop people avoiding IHT completely by giving all their assets away on their deathbed. If you don't live for seven years, the total amount of these gifts, known as potentially exempt transfers, will be added back on to the value of your estate and could be taxed at 40 per cent when you die.

You are allowed to make wedding gifts of pounds 5,000 to each of your children, pounds 2,500 to your grandchildren and up to pounds 1,000 to anyone else. You are allowed to make maintenance payments to your spouse or former spouse, any dependent relatives and, usually, your children under 18 or in full- time education.

On top of that, you are allowed to give away pounds 3,000 a year and can carry over that allowance to the next year if you don't use it all. You can make one-off gifts of up to pounds 250 to as many people as you like as long as you have not given them money under any of the other exemptions.

Any gift must be made "without reservation", which means you have no claim to the asset once it has been given away. "If I give my house to my children on the understanding that I can continue to live there, that would be counted as a gift with reservation, which means that it remains within my estate," explains Maurice Fitzpatrick, a tax expert at accountants Chantrey Vellacott.

Despite the restrictions, there is still plenty of scope for giving large amounts of money away. "No one who is seriously well off should pay much inheritance tax. Those who do are greedy, stupid or badly advised," says Mr Fitzpatrick.

The people who end up paying IHT tend to be well off, but not seriously well off. If you are worth pounds 10m you can afford to give away 90 per cent of your wealth because you know pounds 1m is going to be enough to live on. So if you do pay any IHT the effective rate is very low.

But if you have a house worth pounds 200,000 and the same amount in savings, you are unlikely to feel comfortable giving 90 per cent of your estate away - you would have to sell your house for a start. So when you die you could end up having tax levied on around half of your estate. It is these people who need to think about reducing their potential IHT bill.

"The idea that it is a voluntary tax is based on the premise that in theory you can just give all your assets away and live for seven years," says Mr Fitzpatrick. "It doesn't work like that in practice because people are reluctant to give all of their assets away. Either they don't have any obvious heirs, or they don't like their heirs, or they are worried that they might need the money."

"In my view, inheritance tax is inherently unfair. It hits people in the middle too hard and it's too easy to avoid at the top end," says Mike Warburton, a partner at accountants Grant Thornton. He advises making a will as the first step towards reducing your IHT exposure.

According to the Law Society, only one in three people who should have a will have actually bothered to get one. "It will save a lot of mess for your beneficiaries when you are dead and it will enable you to take full advantage of the IHT exemptions," Mr Warburton says.

Simple measures such as leaving part of your estate to your children instead of leaving it all to your spouse can help avoid an IHT bill when your spouse dies, he explains. It is also worth considering what should happen to any money paid out by any life insurance policies. Making sure payments go into a trust instead of straight to your spouse can avoid or reduce an IHT bill.

A less obvious step is to make sure you have a proper pension - if you know you have a guaranteed income, you can think more clearly about whether you can afford to give assets away.

Mr Warburton adds that this is a good time to think about IHT planning because an incoming Labour government might limit the ability to give assets away.

"I don't think they would attack gifts that have already been made because that would be retrospective legislation. So people need to think about what they can afford to give away now and then plan accordingly," he says.