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How to cut the IHT bill

7/ 7/2008

RECENT changes to inheritance tax rules have done nothing to help single people. We showed one reader the steps she could take to reduce her bill.

Which? Money reader Maureen Dalton was keen to minimise the inheritance tax bill she will leave her heirs. Maureen is single, with no dependents, and wants whatever she leaves behind to be split between a couple of charities, four nieces, one nephew and two godchildren.

If Maureen died now, the state would claim inheritance tax of just over £120,000. However, because most of her wealth is tied up in her home, cutting the bill will be tricky.

What Maureen can do is to start passing over some of her surplus money now, using the tax-free gift exemptions allowed under the IHT rules:

£3,000 can be gifted tax-free each year. Maureen could decide to split the £3,000 between her five relatives and give them £500 a year each.

She could also make use of an exemption called `expenditure out of normal income'. This allows you to give away money from surplus income provided the gift doesn't reduce your standard of living and is not from capital.

If one of her beneficiaries marries or enters into a civil partnership, Maureen can give up to £2,500 tax-free if she is related to one of the couple, and £1,000 if not.

Any gifts to charity while she is alive or after her death are completely free of IHT.

Another option is to insure against the tax bill by taking out a `whole of life' insurance policy for £120,000, under trust, for the people she wants to benefit. This would cost between £185 and £200 a month, so might end up an expensive option.

Six-step action plan

1 Value your estate by adding up the value of any money you have and everything you own (including any assets or property abroad) and deducting any debts against the estate (like mortgages). Also take off reasonable funeral expenses.

2 Currently inheritance tax is paid at a rate of 40 per cent on assets or money over £312,000 if you are single, or up to £624,000 for married couples or civil partners.

3 Make full use of the annual IHT exemptions.

4 If you don't use the £3,000 exemption in one year, you can roll it over and give £6,000 tax-free in the next year.

5 Put life insurance policies into trust. This means the benefit can be paid out without waiting for probate and is free of tax. The 'gift' for IHT purposes is the monthly premium.

6 Most gifts you make to people (as opposed to businesses or trusts) will be treated as `potentially exempt'. This means that if you survive the gift by seven years or more it won't be counted for IHT.