Advice on inherited wealth: pass it on

Worried about your family estate?

John Major's attempt to preserve the Government's reputation as the defender of individuals who want to pass wealth on to their children means he is committed to abolishing inheritance tax.

As a first step, the Chancellor announced in the Budget last November an increase in the starting point for inheritance tax from pounds 154,000 to pounds 200,000, from 6 April this year. Assets above the threshold are taxed at 40 per cent, unless they are left to a spouse or a recognised beneficiary, such as a charity or a political party.

The fact is, however, that the main threat to middle-class voters' estates, and their hopes of passing on their money to their children, is no longer inheritance tax.

The main threat is the very real risk of estates being depleted and family homes sold off to pay for the old folk to go into a nursing home when they can no longer look after themselves.

An estimated 40,000 homes are now being sold each year to pay for the costs of care - costs that run to at least pounds 500m a year.

Arguably, however, only a minority of old people will actually end up in a nursing home, while only a minority of voters are aware of the growing threat of care costs to their inheritance, which bites at a much lower level than inheritance tax.

For the time being, inheritance tax is seen as the threat and the Prime Minister as the main hope of avoiding it. Certainly, the assets of the 600,000 people who die in the current tax year will be docked by pounds 1.5bn to pay inheritance tax (IHT), according to the chartered accountants Clark Whitehill.

Not all that money can be protected from IHT, unless wealthy people are willing and able to give away everything they own in excess of the starting point for inheritance tax, and can then live at least seven years without running short of money.

IHT applies to gifts as well as bequests. Certain items, such as money paid out for the maintenance of dependants, waivers of interest on earnings, and interest-free loans are not regarded as gifts and so are not potentially taxable.

Individuals can also give away up to pounds 3,000 a year in lump sums, plus up to pounds 250 a year in small gifts without incurring a liability.

But if they live for less than a further seven years, any other assets they gave away in excess of this allowance are added back to their actual estate for tax purposes, on the basis of a sliding scale.

If a donor dies within three years, any tax liability has to be paid in full. After three or four years, tax due is payable at 80 per cent of the full rate, in the fifth year at 60 per cent, 40 per cent in the sixth and in the final year only 20 per cent is payable.

If they give away too much, they could run out of money for living expenses, especially if the bulk of the estate is tied up in the family home. The tax-man takes a dim view of income being fed back to donors, or of donors living rent free in property they have given away to avoid tax.

Life assurance policies are also considered as part of the estate, and the proceeds are added to other assets for tax purposes. But if the policy is written in trust for a named beneficiary or beneficiaries, or the policy is assigned to a beneficiary, it is exempt from tax.

Death benefits due on a pension policy are tax-free if they have been specifically assigned to a named beneficiary or beneficiaries. But assigned policies can easily be recovered.

The next best way of avoiding inheritance tax is to create an investment fund that will be sufficient to pay all, or part of, any otherwise unavoidable inheritance tax liability - even if it is itself taxable.

Even if this is a tall order for most people, the importance of planning in order to avoid inheritance tax for one's dependants still remains.