Cash clinic: How can I avoid paying substantial inheritance tax?

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I’m now at the age where I’m starting to consider the future and how I plan to leave my estate to my children, so I’m in need of some advice on the best course of action to avoid my children paying substantial inheritance tax (IHT).

I know that the threshold has been frozen at £325,000 until at least 2018 but is there anything else I need to consider? I am not comfortable with the prospect of giving away or losing control of large sums of capital at this stage.

EH Carnoustie

A With HMRC estimating that some 21,000 estates in the UK paid IHT at 40 per cent in 2012-13, this can be a concern for anyone considering leaving an estate to their family. There are several ways of mitigating IHT but this is a complex area of financial planning, requiring ongoing and regular review due to ever-changing legislation in this area.

Everyone is entitled to certain IHT exemptions which, if not utilised are lost. The most commonly known exemption is the £3,000 “gift” per tax year, an entitlement that if not used in one tax year can be carried forward for one year only. So use it, or lose it!

A lesser known – but incredibly useful – exemption is “gifting” as part of your normal expenditure from your income. There is no financial limit on this exemption; however, you must ensure that the gifts form a regular pattern and are from your income and not capital. In addition, your standard of living must not be impacted as a result of making the gifts.

This allowance can be used to help with education costs, to make contributions to pensions on behalf of grandchildren (up to a maximum of £3,600 a year) or to fund a “whole of life” policy, which will pay any IHT liability on your death.

These options allow you to potentially mitigate or lower any IHT liability without relinquishing control of your capital.

Alternatively, if you decide at any point that you are in a position to gift capital you can make outright gifts to family members or any other beneficiary. These gifts remain within your estate for seven years, thereafter they are outwith your estate for inheritance tax purposes.

Any gift of this nature will no longer be under your control and the beneficiary has the right to do whatever the want with the gift.

If you don’t want to hand over complete control, another option is to use a trust, which will allow you to gift the capital away; however, it is not necessarily available to any beneficiary immediately.

There are different types of trusts available, all with different purposes, advantages and disadvantages and tax regimes, so it is essential that you seek independent advice when considering a trust so that it works the way you want it to.

You can also leave any part of your estate above the nil rate band to charity on your death. In this instance there is no inheritance tax liability payable on charitable gifts.

IHT legislation frequently changes and really does require careful planning and documenting to ensure your actions meet HM Revenue & Customs criteria as the onus is on the executors of your estate to prove allowances used and justifiable.

However, careful planning and discussion with your family can minimise any tax liabilities for them – and the associated distress – when the time comes.

• Laura Finnie is a director at Kelvin Financial Planning

If you have a question you need answered, write to Jeff Salway c/o The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: