Don't leave it all to the Chancellor

An estimated 2.4 million homeowners could now be liable for inheritance tax because of the value of their properties, according to statistics released last week by Halifax Financial Services. The company estimates that the number of properties valued at more than £263,000 - the IHT threshold - rose by almost 500,000 in the first half of this year.

'The maths is straightforward,' says Halifax. 'The 12 per cent increase in house prices in the first half of 2004 significantly outstripped the 3.1 per cent increase in the IHT threshold in April from £255,000 to £263,000.'

Where once inheritance tax was of concern only to the seriously well-off, it is now starting to haunt suburbia. As the subject is complex, it helps to have informed questions to put to your accountant, solicitor or independent financial adviser.

One accountant says impatiently: 'If people would only plan ahead, then inheritance tax will not be heavy.' Many people have an almost superstitious block about inheritance planning.

Matt Leach of Skipton Financial Services says: ' It is easy to sort inheritance tax if you have plenty of assets. Much harder is to help are those middle-income people who will need some money in their old age.'

It is helpful to understand that when a gift is made, inheritance tax is not concerned with what is given, but with the loss to the donor. For example, the Inland Revenue doesn't like people giving away assets to avoid inheritance tax while still benefiting from those assets. A case in point is people continuing to live in the family home after it has been given away.

A new rule comes into force in April 2005 which says that if you made a gift after March 1986 and en joyed the 'reserved benefit' of that gift (but, wait for it, without being caught by the 'gifts with reservation' rules), then you might find yourself paying not 34 per cent but 40 per cent income tax on the value of the benefit. The law is retrospective, so anyone making gifts in the past 18 years could be affected.

Brian King of IHT specialist Christchurch Consultancy is clear about the issue of the Revenue taking more of a person's assets: 'The courts have ruled that every citizen has a right to pay the least amount of tax possible within the law, and to impose a retrospective law will have a severe effect on quite a few people.'

Kevin Tooze of independent financial adviser Equal Partners gets back to basics: 'It is amazing how little people think about how to leave their money on death - you discover that they haven't even written a will. This is the first thing everyone must do, regardless of their wealth.'

It's good to know that the Inland Revenue won't tax your funeral costs or donations to charity. It's also heartening that 96 per cent of the population don't qualify for inheritance tax. But given rising house prices, the current £263,000 below which everyone is exempt from 40 per cent inheri tance tax isn't very much.

'Remember to include your house, car, savings, valuables, even life assurance, when working out what you are worth,' says Tooze, an IFA with Equal Partners. 'Even though inflation is low, house values have soared.'

Accountant Hugh Williams warns: 'There are lots of IHT pitfalls and we recommend our clients use inheritance tax specialists for this complicated area rather than IFAs, simply because they really know the subject. It can be dangerous to give away so much a year to relations to beat the tax man if you aren't sure you have provided for the long term.'

Victoria Amey, an IFA with Professional Partnerships, agrees. 'It's important for people to work out their financial needs before organising will trusts,' she says. 'How much private medical care do they have? How much cash set aside for long term care? We recommend they take out an annuity to help cover future needs, and house selling is a popular way of bringing in capital.'

She continues: 'People are put off by trusts [see below], but a simple flexible trust can cost as little as £1,000 plus VAT to set up. You can protect assets from inheritance tax totalling as little as £25,000-£50,000.'

Hester Bridgenorth, who lives in the West Country, says: 'I know nothing about money - my husband always dealt with it. But about three and a half years ago, when I reached my late 70s, I thought I had do something about inheritance tax, largely because of the rising value of my house. It seems such a waste to leave most of it to Gordon Brown."

She says of her property: 'It is only an old farmhouse, barns and outhouses with six acres, but people want to buy round here now. My accountant recommended a specialist who came to see me, and now everything is settled and I have to live for seven years before it is all safe from tax and can be left to my daughter and her family.'

Keeping IHT at bay

Exemption: The idea is to seek inheritance tax relief for your assets. You can make small cash gifts each year.

Nil-rate band: This refers to the tax-free assets that the Inland Revenue allows on an estate. It is currently £263,000, and goes up in line with inflation each year. The first spouse dies and the remaining spouse inherits the nil-rate band. Any lawyer worth his or her wig should alert a married couple to the importance of using both nil rate bands to save tax. For example, Mr and Mrs Wellbeloved have assets of £600,000. When Mr Wellbeloved dies, £263,000 is given away to relations, free of tax, assuming Mrs Wellbeloved can afford to do this. When she dies, another £263,000 will be allowed free of inheritance tax, leaving only £74,000 liable for tax at 40 per cent.

Seven-year rule: During your lifetime you can give away any assets you wish. To avoid inheritance tax at 40 per cent, you have to live seven years after the gift has been made. Until the seven years have elapsed this is known as a Potentially Exempt Transfer (Pet).

A trust fund is a vehicle which can reduce the amount of IHT payable. Shares, property, insurance bonds or cash are put in a trust fund and, assuming it is established for seven years before the person dies, it will avoid IHT.

A discretionary trust is useful and flexible because anybody can benefit (grandchildren, for instance) without complications. But the IR doesn't want to encourage these, so you have to pay some tax as you go in, and there's also a small tax charge every 10 years.

Deed of variation of a will is fairly common, giving the beneficiaries two years after the death to sort out the will.

Discounted transfer schemes are popular because someone can give away £100,000 and can receive back, say, £5,000 income each year. It results in an immediate reduction of the potential IHT liability.

Life cover should always be written 'in trust'. If someone takes out £100,000 term assurance to cover his mortgage and puts it 'in trust', when he dies the sum goes tax free to his family. Many IFAs recommend taking out a whole-life policy to cover inheritance tax, but this may not necessarily a good choice.

Contacts

HM Williams Chartered Accountants' 'Tax Answers at a Glance', Lawpak ?7.99. 01752 334950

Christchurch Consultancy, 01285 656304

Equal Partners, 020 78670038

Professional Partnerships, 020 7353 9393

Skipton Financial Services, 0800 389 8395

Inland Revenue: Helpline 0845 3020900.