andy chapman

Inheritance tax is for many people voluntary. You needn't pay it, yet millions do. A few simple tricks can save a married couple possibly £100,000s. It's worth taking five minutes to check you're not going to give your cash away to the Treasury.

Don't give it all away!

Everyone's estate is assessed individually when they die. Currently, providing it is less than £300,000 (the nil rate band limit in 2007/08) it is untaxed. This sounds a lot, but with the rise in house prices many more people are affected.

Yet, even if your estate is bigger than that, anything you leave to your spouse or a registered civil partner, provided they’re UK domiciled, is exempt from inheritance tax. Cohabiters do not get the exemption.

People often assume this means it's good to leave everything to your partner, yet actually the opposite is true. The simplest and most effective inheritance tax planning is to make sure both partners use their nil-rate band to the full; this way together you can leave £600,000 to your heirs tax-free.

A simple example should help:

Mr & Mrs Gettingonabit, Are they worth? £750,000 in combination ?
The unplanned route: leave everything to each other

Suppose their wills say when one dies everything passes to the spouse. Let's say Mr G dies (it's the same either way round). Everything passes tax-free to Mrs G, who now, alone, is worth £750,000.
When Mrs G dies, if she has the same amount left, she leaves everything to her three grown-up daughters, the little Gettingonabits. Yet she only gets one inheritance tax free allowance of £300,000; the rest is taxed at 40%.

Calculating the bill. The estate is £750,000 minus the £300,000 which equals £450,000. Forty percent tax on this is £180,000.
Total Inheritance Tax: £180,000 – a huge whack

The planned route: give to the little Gettingonabits

Now both Mr & Mrs Gettingonabit arrange their wills to leave an amount equal to the nil rate band to the little Gettingonabits if they die before the spouse. When Mr G dies their three daughters now get £300,000 between them and there is no inheritance tax.
This means Mrs G is now worth only £450,000. When she dies and leaves everything to the daughters she still has the £300,000 tax free allowance but she is worth less.

Calculating the bill. Mrs G is now worth £450,000. Minus the £300,000, this makes IHT payable on only £150,000. Forty percent tax on this is £60,000.

Of course, this does mean that Mrs G has less money, so you’ll need to consider how well you can actually do this, but the theory shows how powerful the saving is.

Rather than leave large lumps of dosh to your spendthrift kids, you can put it in a discretionary trust. That way a friend or relative can watch that they only get the money for things they need and you can leave a letter of wishes saying how you'd like the money spent. Discretionary trusts involve a great deal of administration and expense and the revenue will object if you've not done everything exactly according to the book so you will need professional advice if you go down this route.

Total Inheritance Tax: £60,000

Therefore in this example the TOTAL SAVING is a massive £120,000

If you don't get your planning in before you die, your heirs can vary your will within two years of your death, if everyone involved agrees. Yet this is a poor second best because it causes some other tax problems and there is no guarantee that this law will survive forever.

Supplied by Martinsmoneytips
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Updated 21/03/08
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Q. Why do we have to pay it?

A. The politics of Inheritance Tax are among the most controversial around; just ask the pre-Revolution French aristocracy! The idea is that without it you perpetuate inherited wealth, so the children of the rich stay rich; Inheritance Tax redistributes income so some of the money goes to the state to be distributed for the benefit of all. The argument against is that when money’s earned tax is paid then, so to pay tax on it again is simply not fair.

After years of rocketing house prices, many more people have been caught by the Inheritance Tax threshold, raising it higher up the agenda. Yet, whatever your views politically, Inheritance Tax is a financial fact, so it makes MoneySaving sense to know how it will affect you, and whether you can soften the blow.



Q. What’s the nil-rate threshold?

A. Everyone is allowed to leave up to a certain amount without their inheritors needing to pay tax on it. The amount is set by the government and is called the nil-rate band, because it’s the amount you pay a ‘nil-rate’ of Inheritance Tax on.

Currently everyone is able to leave £300,000 completely tax-free, and this amount will be gradually increased so that by 2010 it’ll be £350,000.

Above that amount, anything you leave behind is subject to tax of 40%. So for example, if you leave behind assets worth £500,000, your estate pays nothing on the first £300k, and 40% on the remaining £200k – a total of £80,000 in tax.



Q. Does this change if I’m married?

A. When you die any assets left to your spouse or registered civil partner, provided they’re UK-domiciled, are exempt from inheritance tax. On top of this, your partner’s Inheritance Tax allowance is increased by the amount you didn’t leave to others, meaning together a couple can currently leave £600,000 tax-free.

This can sound complicated, so here’s an example:

Mr and Mrs Youngatheart have assets worth £750,000 between them. Let’s say Mr Y dies first, and leaves £200,000 to their children, the little Youngathearts. The remaining £100,000 of his nil-rate allowance will pass on to Mrs Y, giving his wife an allowance of £400,000.


When she passes away, with assets of £550,000, as Mr Youngatheart didn’t use his full nil rate allowance she’ll owe 40% on everything left behind above £400k, meaning £60,000 (forty percent of £150,000) will be payable in tax, leaving all the rest (£490,000) to the little Youngathearts
Total Inheritance Tax = £60,000

Q. Has it always worked this way?

A. No. Prior to October 2007 leaving everything to a spouse could be tax inefficient. When the second spouse then died, anything over £300,000 out of your joint assets was exposed to the taxman’s cold fingers, effectively meaning one partner had wasted their tax-free allowance.

It was possible to get around this by strategically leaving money to other family and friends, making sure that both partners got the full benefit of their allowances. Very many people set up ‘discretionary trusts’ in their wills so that the first spouse to die got the benefit of the nil rate band. This planning still works, but because the rules have changed it is no longer necessary.

Q. What if my partner died before the rules changed?

A. The government has said the new rules will be backdated indefinitely. This means if your partner didn’t take up all of their tax-free allowance at the time of their death, you are eligible to use some of it when you pass away.

We are waiting to see the detailed rules on how this will work, but you should not need to do anything now to activate this. The key to how much extra you get relies on the proportion (not the amount) of their allowance that your spouse used. If they used 50% of the nil-rate allocation at the time of their death, then you will get 50% of the current 2007/8 allowance in addition to your personal £300,000.

An example should help explain this:

"Let’s say Mr Youngatheart had passed away some years before Mrs Youngatheart, back when the nil-rate allowance was only £250,000. He gave £50,000 to each of his three children, meaning £150,000 had been used – 60% of his allowance. All the rest went to Mrs Youngatheart.

When she dies, of course she can now pass on £300,000 free of tax due to her own allowance. Yet she can also pass on the unused amount of Mr Youngatheart’s allowance. He didn’t use 40% of his, so she gets another 40% of the current nil-rate amount, i.e. £120,000 without paying tax. This means her total nil-rate band is now £420,000.

Q. Can I reduce the bill in any other way?

A. Money given away before you die is still usually counted as part of your estate, hence subject to Inheritance Tax, if you die within seven years of giving the gift. Therefore one golden rule is to try and survive more than seven years (vitamin tablets anyone?) - which means early planning of how to pass on your assets is important. Living longer is a good idea anyway!

If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential IHT bill. Most gifts into trust are now subject to IHT even if made during your lifetime, but this is an area where you would need specialist advice.

However, even if you do die within seven years of making a gift, there are a range of other exemptions worth taking into account to help lessen the tax bill.

Annual Inheritance Tax Exemption. The first £3,000 given away each tax year is completely ignored as part of your estate and thus not subject to Inheritance Tax if you died. If you don’t use this in a year, you can carry it forward for one tax year (no more) and use it then.


Gifts to charities and political parties are Inheritance Tax free. Hence leaving money to that cats' home is at least efficient tax planning.


Give £250 each year to everyone you know. Gifts of no more than £250 to any one recipient per tax year are excluded from inheritance tax. For example someone with 12 grandchildren could give each of them £250 annually as a birthday present and it wouldn't be counted as part of the estate. This soon helps chip away at the bill.


Gifts from income. Inheritance Tax is a tax on your assets. However if you have an income (pension or earnings for example) and you give money regularly from that which leaves you enough income not to impact your lifestyle, then it is exempt.


Gifts on consideration of marriage. You'll love this one. If you give a gift that is conditional on an agreement of marriage i.e. "marry my daughter and I will give you X thousand pounds" it is exempt. There are limits to this though: £5,000 for a gift from a parent, £2,500 from a grandparent, £1,000 from anyone else. However, remember this is not a simple wedding gift, that wouldn't count. It must be conditional.

Q. What constitutes a gift?

A. A gift must be a genuine unconditional gift that you will not gain from; something given to someone without any reservation, no nods, winks or mutual back-scratching. The biggest asset most people have is their house, yet trying to give half of this to your descendents won't work if you continue to live in it.

All the gifts above are valid ways of reducing your Inheritance Tax bill. Yet if any are given conditionally, with the intention of receiving something in return, they could be unlawful so watch out.



Q. Should I get advice?

A. Inheritance Tax is clearly a huge area of MoneySaving; after all you don’t want to be super-savvy all your life just to have most of what you’ve saved go to the taxman. If that’s what you’re worried about, there’s a couple of extra things you should think about.

Make a will.

This is actually a really sensible step for anyone thinking about the perils of inheritance tax, and what happens to your money once you’ve gone.

There are many off the shelf will packages, though questions abound about how good they are. If you have a complex situation, you're better off finding a solicitor. Plus there are often free charity will making months; these pop-up regularly over the year. All details will be included in the free weekly MoneySaving email

Get tax advice.

While I normally tell people to try and do things themselves as it's much cheaper, if you have sizeable assets Inheritance Tax is one of the few occasions I think paying for good professional legal or tax advice is well worth the money – a few hundred quid to save £100,000s.

Yet first of all consider if you’re even caught by Inheritance Tax at all – if you and your spouse’s total assets are under £600,000 (so house value, savings, inheritance, and what’d be left from your pension) you shouldn’t pay the tax anyway; so there’s little point.

However, for those with bigger estates an IFA may, depending on their qualification, be able to help (see the Independent Financial Advice article), but a solicitor or tax accountant is a better bet for more specialised info. Preferably find one who is a member of the Society of Trust and Estate Practitioners; take a look on the STEP and Chartered Institute Of Taxation websites.



Oh and finally, IHT planning is important, but don't forget, the main thing is that you (or your parents) should have financial security in old age; don’t sacrifice everything just to plan for someone else’s future. You’ve earned your money, so let it make you comfortable.