The abolition of inheritance tax is on the agenda again. But why wait? With some planning, you can reduce its effect straight away.
Few things seem to work up the great voting public more than inheritance tax. Last week the Tories lit the touch paper again by suggesting it should be abolished. Although it was just one paragraph in a 200+ page document, it was the section that garnered all the headlines.
An insignificant tax
In many ways the furore surrounding what inheritance tax generates is overdone. It accounts for £4bn of tax revenues. That sounds like a lot but is, in fact, less than 1% of the £453bn in total tax revenues that is expected to be collected this year. Indeed, income tax and national insurance combined will haul in 60 times more than inheritance tax.
Consequently, complaints that abolishing inheritance tax will hit public spending in any significant way are clearly nonsense. They probably come from the same people that put the government in charge of the weather this summer.
But when it hits, it hurts....
Very few people end up paying inheritance tax. Only 6% of estates pay it at the moment - that's around 35,000 people a year. Of course, you could argue that more people are affected by it, as an estate will often have a number of beneficiaries. Estates that do suffer inheritance tax pay an average of £114,000. This is far larger than any other tax, which isn't surprising of course as no other tax affects all your assets at the same time.
Some people are predicting that more people will get caught by inheritance tax in future. The same people are conveniently selling tax planning services, but they are probably correct. Still, at least the inheritance tax regime is less punishing than it was in the past. In the 1970s, its predecessor, capital transfer tax, kicked in at £10,000 (equivalent to £60,000 in today's money) and had a top rate of 75% for assets over £2m.
Today, inheritance tax is charged on estates over £300,000, with 40% tax paid on any assets over this threshold.
Reducing your inheritance tax bill
There a number of things you can to reduce your inheritance tax liability now. Relying on the fact that it might get abolished in future seems rather optimistic to say the least, as even the latest proposals were still proposing some sort of tax on assets other than the main family home.
This is one area where you should get professional advice, especially where larger sums are involved as tax law can and does change on a frequent basis. Here a few ideas to give you a flavour of what can be done though:
Life insurance
If you have life insurance, consider setting it up in a trust which will mean it gets paid direct to the beneficiary of your choosing. This way it never forms part of your estate, and so won't get assessed for inheritance tax. It will also mean they will receive the money a lot sooner, as they won't have to wait for several months while your estate is sorted out and monies distributed.
Gifts
One way of reducing the value of your estate is to pay out gifts while you're still in fine fettle. If you die within seven years of making any gift it can still become part of your estate and hence subject to inheritance tax, although there a number of exceptions to this.
When someone gets married you can give them £1,000 (if you're their grandparent you can give them £2,500 and parents can give £5,000). You can also give away £3,000 in any one tax year and carry forward any unused amount of this allowance from the previous year. So, two parents could give a child up to £22,000 when they got hitched.
You can also give any number of people £250 a year, although this can't be used to add to the wedding or annual exemptions mentioned above.
You can also make regular gifts out of your income so, for example, wealthy grandparents might be able to pay for school fees or childcare costs. This is apparently one of the least-used exemptions from inheritance tax.
Spouse exemption
Any amount left to your spouse is free from inheritance tax. This can cause a problem when they die however, as leaving all your money to them means you don't take advantage of the £300,000 tax-free threshold. This can be avoided by leaving £300,000 to someone else, and the remainder to your spouse. This can even be done up to two years after your death using what is known as a deed of variation.
Using all of these methods can make a sizeable dent in your eventual inheritance tax bill. Of course, the most reliable method is to spend it all before you go!