Inheritance Tax (United Kingdom) - Minimising IHT

Minimising IHT

In order to avoid IHT, many people in the IHT bracket practise some or all of the following avoidance measures:

• Outright gifts to another individual made during a person's lifetime are known as "potentially exempt transfers" or PETs. They are taxable if the person dies within seven years but have the potential to become exempt from tax once the donor survives seven years. There is no reduction in inheritance tax if the donor dies within three years of the transfer. However, if the donor survives three years, the rate of tax on the PET reduces by one fifth (to 32%) and then by a further fifth on each of the subsequent anniversaries (to 24%, 16% and then 8%) until the PET is fully exempt from inheritance tax after seven years. This is known as inheritance tax taper relief (not to be confused with the better-known capital gains tax taper relief).

• Giving assets to a trust fund before death. (Some gifts of this kind, however, are disadvantageous as they amount to lifetime chargeable transfers on which half the IHT is due immediately if the cumulative total of chargeable gains gifted exceeds the nil-rate band (£325,000 in 2009/10). This applies to many more trusts, including discretionary/flexible trusts, than previously under legislation introduced by the 2006 budget. See Taxation of trusts (United Kingdom).)

• Certain special types of trust, such as a Discounted Gift Trust, which allow for capital to be given whilst retaining a lifelong access to an income stream from said capital (and which, where the settlor is in reasonably good health, are one of very few planning arrangements with an immediate reduction in inheritance tax liability), and gift and loan Trusts.

• Inheritance tax solutions based around Business Property Relief qualifying investments, including Enterprise Investment Schemes.

• Charitable giving, which is IHT exempt.

• Lifetime gifts within certain limits are completely exempt. These include any number of "small gifts" (up to £250 per recipient per year), an annual amount of £3,000, all regular gifts from surplus income, and some wedding gifts.

• Upon death (by will or intestacy) the passing of non-taxable assets to the next generation (or to a discretionary trust for the benefit of the whole family) and therefore not to the spouse. This may seem counterintuitive because both current and future gifts to a spouse are IHT exempt and were therefore before 2007 to be maximised. However, if something is non-taxable on the first death it should not go to the spouse as it will merely increase their tax estate upon their later death. (The nil-band discretionary trust, discussed below, is an example of this principle in action.) Following the October 2007 change, this strategy may no longer be necessary, and may if the nil rate band threshold increases to reflect perhaps expected average rises in wealth result for wealthier couples (i.e. with current combined wealth over £650,000) in less tax-free estate for a couple's beneficiaries.

• Selling one's property to a home reversion plan, which is a type of Equity release scheme and using the resulting income stream to fund a life insurance policy, written in trust for the beneficiaries, so as to replace the lost value of the property.