How to avoid inheritance tax

When you die you will probably want your estate to pass on to your children, but paying Inheritance Tax (IHT) could significantly reduce the amount they receive.

However, there are a number of things you can do to limit the amount of IHT your loved ones have to pay.

Below we outline some of the most effective tips to help keep the taxman away from your estate when you die…

Give a gift to your partner

If you are married or in a civil partnership you can give away anything you own to your partner so that your estate will not have to pay Inheritance Tax on whatever the gift is worth (this only applies if your spouse was born in the UK, if not the value of the gift may be limited.

The rules around this are notoriously complicated, however, so always take advice before you do anything.

Give a gift to other family members (i.e. children)

A gift to other family members such as your children is also free from Inheritance Tax, as long as you don’t pass away within seven years of giving the gift.

Such gifts are known as PETs, or potentially exempt transfers, and providing you live for at least seven years are completely exempt from IHT.

On top of this you can give gifts totalling £3,000 to family members each year without fearing any tax repercussions, as well as £5,000 in the event of a family members wedding.

Set up a trust

Another option is to place some of your money, investments and/or property into a trust which you, your partner and your children under 18 cannot benefit from – as this will mean those assets are no longer part of your estate in regards to Inheritance Tax.

For instance, you could set up a trust to benefit your adult children so they can pay for their children’s education in the future.

A trust can be set up right away, or you could choose to establish one in your will. If you choose to set up a trust during your lifetime then you may have some Capital Gains Tax consequences (depending on what assets you put into the trust), but if you set up a trust in your will there will be no Capital Gains Tax liability.

It’s worth noting that some types of trust are subject to their own tax laws, and trustees could be required to pay Income Tax (45%) and Capital Gains Tax (28%).

Take out a life insurance policy

A life insurance policy won’t reduce the amount of IHT your estate has to pay, but the payout on the policy can enable your loved ones to pay the Inheritance Tax bill.

If you do choose this option, make sure the life insurance payout goes into a trust so that it does not form part of your estate.

Advantages of writing a life insurance policy in trust

Trusts can help to cover inheritance tax

  • This is seen as the biggest advantage to having a policy in trust as without one, the payout may be subject to inheritance tax.
  • After death, if the value of your estate is £325,000 or more, everything you own above this threshold will be liable to inheritance tax at 40%.
  • By writing your life insurance policy in trust, the payout would go straight to the beneficiaries and therefore not taken into account when inheritance tax is calculated.

Granting probate is not needed

  • Probate is the legal process which confirms an executor’s authority to deal with the money and possessions you leave behind. So if you leave everything to your spouse, they will have to get probate granted before being able to distribute your estate. This process can take a long time.
  • With a life insurance policy in trust, then the policy payout can be granted before probate is issued, as all the insurance company will request is a copy of the death certificate.
  • This means that the family face less worries about when your insurance policy payout will come through (without a trust this can take months).

You will have greater control over your policy

  • Writing your life insurance in trust will allow you to specify how you want the payout to be distributed after you pass away.
  • Without having life insurance in trust, the money could go to paying off debts instead of going to dependants as you would like.

You should take appropriate legal advice before setting your trust up. This will confirm that you have the right arrangement in place to suit your needs.

Other things to note are that writing your life insurance in trust does not cost any extra, and if you already have a policy in place then most companies will allow you to transfer this into trust.

Make a charitable donation

Any amount you give to charity is exempt from Inheritance Tax, so it can be an effective way of reducing your liability – while benefiting a good cause.

Also, if you give away at least 10% of your estate to charity it will reduce the rate of IHT you have to pay on the remainder (down to 36% rather than 40%)

This might not work out to be a huge saving, but it could mean that your family will receive more than they would do otherwise.