Four ways to cut your IHT bill

Natalie Stanton explains how you can manage your finances later in life to ensure your family isn’t charged more than necessary when you die.

Inheritance tax (IHT) is deeply unpopular with MoneyWeek readers. It's also highly lucrative for the government: in the year to April 2016, the Treasury pocketed £4.66bn from IHT, and by 2021 this is expected to rise to more than £5.7bn per year. However, there are ways that you can manage your finances later in life to ensure your family isn't charged more than necessary when you die.

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First, thanks to very generous rules brought in by George Osborne two years ago, defined contribution (DC) pension funds can be passed on to your heirs without paying any IHT (they just pay income tax at their marginal rate when they withdraw the money). This means that while our pension fund used to be the main way for us to generate a retirement income, today they are pretty much the last thing you want to touch if your priority is to minimise IHT. Instead, you should focus on running down your other assets outside the pension and leaving as much as possible within the pension wrapper.

This doesn't apply to defined benefit (DB) pensions (those that pay you a fixed percentage of your salary in retirement). For this reason, increasing numbers of savers are apparently transferring their DB pension benefits into a DC pension. This always used to be seen as a very unwise move the certainity of what you'd get from a DB scheme was too valuable to give up but the IHT benefits of DC pension funds have changed that calculation a bit.

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We're still not convinced it's the best option it's possible the new generous IHT benefits for DC pensions will be reduced in future and you'd have given up your cast-iron DB pension promise for nothing, but it's easy to see why people are attracted to it. However, if you're fortunate enough to have a DB pension and you don't need the income from it, a less irrevocable option is to gift that income to your heirs each year. You can give up to £3,000 per person with no potential IHT being due and larger gifts are IHT-free if you live for more than seven years after making them.

What if you've got far more outside your pension than you'll need? The other major asset for many people is their house. Last year's IHT changes mean that with effect from April 2017, everybody will get a £175,000 "family home allowance" on top of the standard £325,000 inheritance tax allowance when leaving their main home to their direct descendants. This means that a married couple can pass on a home worth up to £1m tax-free.

However, for those with substantial assets, this may still not be enough. So a further option is to invest some in stocks listed on Aim, the UK's market for smaller companies. Many although not all Aim stocks will qualify for "business property relief" once held for two years, and so will pass on to beneficiaries IHT-free.



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