How can you avoid paying inheritance tax?

Middle-class families are being trapped by a tax designed for the rich reports Alex Rankine. He explains ways which inheritance tax (IHT) can be avoided.

(Image credit: © Getty Images)

More and more people are being obliged to pay inheritance tax (IHT). The number of families liable rose by almost a third last year, says Harry Brennan in The Daily Telegraph. “Designed for the rich”, the charge is increasingly hitting “middle-class families”, especially in the southeast of England, where house prices have soared.

IHT is levied at a rate of 40% on estates worth more than £325,000, a threshold frozen until 2026. In 2017 the government introduced the “main residence nil-rate band”. This additional band exempts all or part of the value of the family home from IHT provided the beneficiary is a child or grandchild. In practice, that means that an individual can usually bequeath up to £500,000 and a couple up to £1m before the taxman comes knocking.

You can also keep this allowance if you downsize, says Danielle Richardson on Keep good records so that the estate’s executors know what to claim. Also note that the residence nil-rate band is tapered for estates worth more than £2m, before disappearing completely for estates worth more than £2.4m.

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Gifts made at least seven years before death are not counted as part of the estate. An added benefit of giving early is that money that helps a child or grandchild get on the property ladder today is much more valuable than the vague promise of a windfall decades in the future.

Gifts have to be genuine, however. The “wheeze” of “giving” your house to the kids only to carry on living in it rent-free doesn’t work, Sarah Coles of Hargreaves Lansdown tells Rebecca Goodman in The Independent. The property will still be “included in your estate” for IHT.

Keep track of gifts

The rules around gift-giving are complex and “poorly understood”, says Emma Agyemang in the Financial Times. “Increasing numbers of beneficiaries” are having to pay tax on gifts. It is important to “keep detailed records” of the amounts given “to provide a paper trail for HMRC”.

One source of confusion is taper relief. The tax charged on gifts made between three and seven years before death is gradually tapered, but most gifts aren’t taxed anyway; they just gobble up the £325,000 tax-free allowance (gifts are applied to the allowance first). Unless you plan to make very substantial gifts before death then don’t count on tapering.

It is worth mugging up on the exemptions for gifts. There are special allowances for wedding gifts and small gifts. Gifts from regular income (not savings) to support a family member’s living costs may also qualify for the “regular-payment allowance”. Those with large estates will find it is worth paying for specially tailored advice. The seven-year rule means it is better to plan well in advance, Svenja Keller of Killik & Co tells Agyemang. “The sweet spot is if you’re in your sixties and seventies, although you can even start thinking about planning in your fifties.”

There is an even easier way to reduce the final bill, of course: spend it. There is nothing wrong with lifelong budgeters finally treating themselves to a cruise.Of course, you can’t give away or splurge all your cash. You want to have enough for retirement and to be prepared for contingencies such as one day needing care. But if you do have money to spare

then it is probably best to give now, note it down, and enjoy life.