Simple ways to reduce IHT bills

Give it away

It’s always worth remembering that the simplest way to avoid inheritance tax (IHT) is to give away excess wealth at the earliest possible opportunity. Of course, that doesn’t mean that people should hand money over to just anyone, although that would work. They’ll want to pass it on to their children, grandchildren, nieces, nephews, etc. The trouble is that if they die within seven years of making the gift, HMRC will treat the money as part of the death estate and charge IHT accordingly. But there are tax breaks that can be can used.

Exempt gifts

The IHT legislation allows exempt gifts of up to £3,000 per year to be made. There are a few other exemptions, however these are aimed at specific types of exempt gift, e.g. to those getting married, and they don’t add up to much. Plus, while somneone might be happy to make gifts of a few thousand pounds a year, they may not be as comfortable handing over tens of thousands. It’s the classic IHT dilemma: to get the capital out of the estate they have to give it away, but if they do that it won’t be there in the event of an emergency. And worse still, at least from a tax point of view, is that it’s growing in value all the time and so increasing the potential IHT bill.

IHT freezing

The insurance industry offers a couple of IHT avoidance products: discounted gift trusts, as well as IHT-efficient investment funds. Both do the job of getting money out of an estate and, at the same time, can generate an income. But they have drawbacks. Like all insurance products they cost money. The insurance company and your a financial advisor won’t be setting the scheme up without fees. A further drawback is that they tend to be inflexible. Once the individual  hands the money over, they’re committed to the terms of the scheme. Getting money out in case of an emergency can be costly, if it’s even possible.

Alternative

As an alternative to insurance products or making a straight gift to the intended beneficiary, individuals could give them an interest-free, open-ended loan, which they can then use to buy investments. The income the investment money generates will be part of their estate for IHT purposes.

Example. Bob makes a loan of £100,000 to his son John which he invests in a combination of shares and cash deposits. Over the following ten years these produce £30,000 of income and £20,000 in capital growth. This all belongs to John. Had it been in Bob’s name the £50,000 increase in value would have been part of his estate and so could have resulted in an IHT bill of £20,000 (£50,000 x 40%).

A loan can be a convenient way to use the exempt gifts allowance. All the lender needs do is write off up to £3,000 of the loan each year. This counts as a gift because it reduces the amount of money they’ll get back.