Avoiding the clauses of death tax can significantly increase your estate

THE Tories have long proposed to increase the inheritance tax (IHT) threshold to £1 million but that looks unlikely under the newly formed coalition between the Conservatives and the Lib Dems.

However, there are already several ways to mitigate IHT. Brian Steeples, managing director of the Turris Partnership and the UK chartered financial planner of the year, shares his tips on reducing IHT liabilities.

1 USE YOUR EXEMPTIONS There are a number of specific exemptions from IHT and, in general, it is sensible to make use of them. Among the more commonly used are the 3,000 annual capital exemption, where 3,000 can be gifted without restriction each year; the ability to gift 250 to as many individuals as you wish (although one recipient cannot receive more than 3,000 in any tax year); and gifting "excess income" which does not reduce your standard of living.

2 GIFT SURPLUS CAPITAL If you have sufficient capital, you can make an outright gift of capital from your estate. The gifted money will normally be outside of your estate for IHT purposes, saving 40 per cent of the value of the gift, provided you survive seven years from the date of the gift. Different rules apply if you are gifting capital into a discretionary trust. In this case, careful professional advice is needed.

3 GIFT MONEY BUT RETAIN INCOME BACK Many people may feel that while they do not need the capital they want some spendable income from the capital. It is possible to use a specialised type of trust that allows you to retain a stream of spendable monthly withdrawals from the trust, without jeopardising the IHT reduction benefits.

In this case, capital is gifted into a discounted gift trust. If properly set up around half of the gifted capital comes out of the estate immediately for IHT purposes and the other half comes out of the estate after seven years. The trust then pays a monthly withdrawal of capital that you are free to spend. The annual withdrawal can be up to 5 per cent of the gifted amount.

4 USING YOUR PENSION FUND You can make substantial IHT savings if you have a pension fund and have not yet taken retirement benefits from it. This involves your pension fund death benefit being paid to your children/grandchildren or a suitable family trust. In the event of your death before drawing your pension, the pension fund would pass to the nominated person free of IHT.

5 IHT FRIENDLY INVESTING Certain types of assets can be exempt from IHT after holding them for a two-year period. These are assets which qualify for business property relief (BPR), including companies listed on the Alternative Investment Market. These are smaller companies and as such the investment risk is greater, although some investment schemes provide capital guarantees on death, protecting the capital and the IHT saving.

6 BORROWING TO INVEST A variation on the above technique is to take out a loan and invest the loan proceeds into the IHT exempt assets. In this case, the loan amount is immediately deducted from the estate and after two years the invested assets are also outside of the estate.

Care needs to be taken, as the loan interest needs to be repaid. In some cases, the interest may be able to be rolled up and this would increase the amount of debt, thus increasing the IHT saving. Like many of these measures this should not be done, however, without careful professional planning.

7 DOUBLE NIL RATE BANDS A married couple (including civil partnerships) can benefit from two nil rate bands (NRBs). Upon death of the first partner, the unused NRB can be transferred to the surviving partner, allowing them to have an effective NRB of 650,000, based on the current 325,000 IHT threshold.

8 REVIEW YOUR ISAS While individual Savings Accounts (Isas) are have income tax and capital gains tax advantages, they will form part of your estate and therefore lose 40 per cent of their value on death. Isas cannot be gifted to anyone else or into a trust. The current income tax benefit on the interest/dividend from Isas therefore needs to be weighed up against the 40 per cent loss of capital on death.

9 PAYING IHT WITH LIFE ASSURANCE A life assurance policy can be put in place so that the amount payable on death can be used towards the payment of the IHT bill. Care needs to be taken to ensure the correct type of life assurance policy is used and the policy is placed into an appropriate type of trust.

10 AVOID THE 14-YEAR TRAP Gifting capital normally triggers a seven-year clock for IHT purposes, but a 14-year clock applies where a chargeable lifetime transfer – such as a gift into a discretionary trust – was made within seven years of a potentially exempt transfer. This can be a complex area and both the timing and the sequent of events are crucial. With careful planning, IHT can often be reduced if not completely avoided, but there are numerous traps for the unwary and professional advice should always be sought.