Cash Clinic: How to ensure your next of kin pay as little tax as possible

Question: I have been told that one of the best ways to mitigate a potential inheritance tax (IHT) bill is to have a life assurance policy. I have estimated that my wife and I have a potential IHT liability of around £300,000. What is the best kind of policy to mitigate this? BS North Berwick

Answer: There are several ways in which the value of an estate can be reduced for IHT purposes, ranging from the very simple to the more sophisticated. Some of the possibilities are set out below, but you should take specialist legal and financial advice as to how and when they might be appropriate.

Small gifts - an individual can make as many outright individual gifts of up to 250 in a year as he/she wishes to separate individuals.

Annual exemption - each individual has an annual allowance for IHT purposes of 3,000.

Normal expenditure out of income - a transfer may be exempt from IHT if it is shown to be made as part of "normal expenditure".

Gifts to charities - these are exempt from IHT provided that the statutory tests are met.

Transfers between spouses - it can be beneficial to divide assets equally between spouses, particularly if one spouse is a non taxpayer and has little or no capital assets. Transfers between spouses are exempt from IHT.

Gifts in consideration of marriage - There are specified amounts which are exempt. The marriage must actually take place.

Other options include setting up trusts; investing in alternative investment market stocks or enterprise investment schemes; gift and loan Schemes, and discounted gift schemes. All of these need specialist advice before proceeding.

Gifts to individuals should be exempt from IHT as long as you live for seven years after making the gift. These sorts of gifts are known as "potentially exempt transfers" (Pets). However, if you give an asset away at any time while retaining an interest in it - for example you give your house away but continue to live in it rent-free - this gift will not be a Pet.

Then we come to IHT insurance policies. There are many options involving whole of life policies which could be investment-backed or guaranteed.

The sum assured of the policy is normally based on the potential IHT bill and can be indexed in line with inflation or at a set percentage.

In your circumstances the cover would often be on a joint-life second-death basis, which means that the policy would become payable at the time that the IHT liability arises.

The policy should written under trust to ensure that the sum assured does not form part of your taxable estate and can be used to pay or mitigate the IHT liability. In certain cases a short-term immediate solution could be the implementation of a term assurance policy.• Glen Gilson is a partner and head of private client & financial services at HBJ Gateley.

If you have a question you need answered, write to Jeff Salway, Personal Finance Editor, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: [email protected]. The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley accept no liability on the basis of this article.