This time, we’re going to be talking about Inheritance Tax Planning or IHT. They call IHT the voluntary tax because there are many easy ways to plan for it. The problem is, none of us know the day we're going to die, which can make timing the planning a bit tricky!

But there are things that everyone can do to plan for this punitive tax, and in this session I'll give you some practical tips to take away and implement.

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Inheritance Tax, or IHT, is a tax payable on death. Sometimes I hear people call it Death Duties, which is what IHT used to be called in 1894 when it was first properly introduced!

IHT accounts for 0.8% of the total money received by the UK Government and was about £2.7Bn in 2011.

Everything you need to KNOW

So, let's deal with everything you need to know about Inheritance Tax

1 – Nil Rate Band

Everyone has a Nil Rate Band. It's the amount you can leave your beneficiaries, without paying IHT. remember, this doesn't apply if you leave everything to your spouse or civil partners – there is never any Inheritance Tax to pay between spouses, no matter how large the estate.

The Nil Rate Band is currently £325,000 per person, and will stay at this level till 2019. If your estate (everything you own) is worth more than this when you die, you will pay 40% tax on everything over that amount.

If your spouse dies without having used their Nil Rate Band, for example by leaving everything to you, when you eventually die their Nil Rate Band will be transferred to you, making your total Nil Rate Band twice whatever the individual band is at the time of your death. Right now

2 – Know your reliefs

One of the reasons IHT is called the voluntary tax is because there are so many reliefs you can use to avoid paying it. Here are the main ones:

Annual Gift Exemption

Anyone can make gifts of £3,000 per donor per year. If you made no gift last year, you can carry forward last year's gift exemption too, allowing you to make £6,000 worth of gifts this year. It doesn't have to be one gift, it can be many gifts – the maximum allowance is per donor, or giver, rather than by recipient.

Remember, you can give away whatever you want, but these exemptions means you can give money away at this level without any Inheritance Tax consequences – more on this below.

Small gifts exemption

Under this exemption, you can make multiple gifts of £250 to as many people as you want. You can't write 100 cheques of £250 to the same person though! It's designed to ensure people can give small gifts without worrying about record keeping or IHT concerns.

Wedding or civil partnership gifts exemption

When someone gets married, or enters into a civil partnership, there is a special exemption for those giving them gifts to celebrate the occasion:

• Parents of the couple can give £5,000
• Grandparents can give £2,500
• Anyone else can give £1,000

Gifts from Income

This is an important, and massively under-used exemption. Put simply, you can give away however much you like to whoever you like, as long as the gifts follow these rules:

• The gifts must be regular, which in practice means at least annually, or more regularly
• The gifts must be made from net (after tax) income
• The gifts must not materially affect standard of living

It is not uncommon for me in my professional capacity to come across older people with decent incomes, but they're only spending half of the income. They can give money away using this exemption, rather than just roll-up the income they're not using and pay Inheritance Tax on it when they die.

Business property relief

If you own a business, or part of one, or certain types of shares, the value of that asset can be Inheritance Tax-free, as long as you have held it for at least 2 years and you still  hold it at the date of your death.

Qualifying business assets must be

• A trading business which makes or sells something (can't just buy and sell shares for instance)
• Either shares in a company which gives you control,
• Shares not listed on a stock market, or
• Shares listed on certain markets, like the Alternative Investment Market
• Land, buildings or machinery used in the business

Agricultural Relief

Agricultural Relief works very similarly to Business Property Relief, but with special rules for farms. To qualify it must be a working farm, not a hobby smallholding or a former farmhouse. There are lists of item which can and can't be included for Agricultural relief purposes, which are beyond the scope of this podcast!

Woodland relief

If you happen to own some woodland(!), then that isn't chargeable to Inheritance Tax – phew.

Charity relief

Finally, any gifts made to a registered charity either while you're alive, or via your will when you're gone are completely free of Inheritance Tax complications.

3 – Know how gifts work

The seven year rule

Most people I speak to about Inheritance Tax have heard of the seven-year rule, but many don't fully understand its workings. If you make a gift, the value of the gift will be added back into your estate for IHT calculation purposes for 7 years. This is to stop people making gifts on their death bed to avoid Inheritance Tax. The gift is added back into the estate on a sliding scale:

• Years 1-3: 100% of the value  of the gift is added back into your estate when calculating Inheritance Tax
• Year 4: 80% of the value of the gift is added back
• Year 5: 60% is added back
• Year 6: 40%
• Year 7: 20%
• year 8 onwards: the gift is out of your estate and is not chargeable to Inheritance Tax at all

In other words, if you live for seven full years after making a gift, it is gone form your estate and will not count towards your Inheritance Tax bill

Gifts like these, to people, are called Potentially Exempt Transfers (PETs) because they might be exempt from IHT if you live 7 years.

Chargeable Lifetime Transfers work much the same way, but are usually gifts made into trusts. In this case, IHT can sometimes be payable when the gift is made, if it is above the Nil Rate Band. I don't suppose many people listening to this will be making gifts of more than £325,000. There may also periodical charges and exit charges on these trusts. Seek advice if this might affect you.

A gift must be a gift

As far as Inheritance Tax is concerned, you can't give something away and retain a benefit. Doing so is called a Gift with Reservation of benefit. For example, I get asked all the time if you can give your house to your children to save Inheritance Tax, and continue to live in it – the answer is NO!

A different example is if you have a valuable painting, give it away to y our children, and yet continue to hang it on your wall. HM Revenue and Customs would just treat it as if you had never given it away at all, and include it in your estate when working out how much Inheritance Tax you have to pay.

Everything you need to DO

So, armed with that information, let's deal with everything you need to DO to pay as little of this punitive tax as possible.

1 – Spend it

The best and most fun way to reduce IHT is to spend it! Surely it is better that you get to spend and enjoy the money, rather than it going to the Exchequer! remember though that spend means spend. If you buy stuff which has a value, you are just exchanging your money for stuff and not reducing the value of your estate!

Instead, exchange money for experiences, like holidays, rather than art!

2 – Give it away

Actually, this is even more fun than spending it. All gifts to charities, whether made when alive or via your will are IHT exempt.

If you're going to give money to family or friends, or anyone really, while you are still alive, keep good records. These will be needed when your executors have to sort out your estate after you've gone.

Finally, when making gifts, be sure to use all the exemptions available to you.

3 – Insure the liability

If you're concerned about giving money away or spending too much money now, the third strategy is to take out life assurance to cover the amount of your likely Inheritance Tax bill, leaving your estate intact.

Here's how to work out your IHT liability:

• Add together everything you own
• Take off any amounts you owe
• Minus the Nil Rate band – £325,000
• What's left is taxable estate
• Multiply this by 0.4 (40%) to get the amount of tax payable

You could then take out whole of life insurance for this amount. All the different types of life insurance were discussed in Session 7

Whatever you do, make sure any life insurance you take out is put in trust. Doing so keeps the money from the policy out of your estate. There is no point just adding it to your estate, it'll only make your Inheritance Tax problem worse!

While you're at it, it is worth checking whether any other life insurances you might have are in trust too. Remember that trusts are complex documents – seek legal advice or help from a competent adviser.

By taking out life insurance, you are essentially paying the Inheritance Tax on the drip – but hopefully not the whole amount!

4 – Consider cash-flow planning

Giving money away or spending more now can be disconcerting – what if you run out of money later? The last thing you want is to have to go without in later years because you have given ‘too much' away now.

Cashflow planning, sometimes called cashflow modelling, can help you to understand how your money will shape up in future. It's a topic for a future session, but using certain assumptions, and knowing your current financial position, your income and outgoings, a competent adviser with some clever software can help map out your financial future.

Doing this, you can model some different scenarios, like needing care in the future, or getting poor investment returns, and then see how these affect your financial health. Then you can make changes to your plans if necessary.

In the context of Inheritance Tax, cashflow modelling could let you know how much you can safely give away, and still ensure that you never run out of money for yourself. A good financial planner can help you here. If your adviser looks at you blankly when you ask them about cashflow planning – sack your adviser! A Certified Financial Planner of CFP, can help you here.

Summary

So, what do you need to know?

• Everyone gets a Nil Rate Band (currently £325,000) and anything over this is chargeable at 40%
• There are exemptions you can use to give money away with no IHT implications
• You should know how the gifts system works

Then, armed with that information, you can:

• Spend it
• Give it away
• Insure the liability
• Use cash-flow planning to make sure you're not leaving yourself short

Outro

That's it for this session of the MM podcast – I hope that was helpful. Did I miss anything? Do you have any tips or tricks that work for you? Do you have any questions?

Please leave any comments or questions in the comments section below, and I'll do my best to answer them.

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Thanks for listening – I'll talk to you next time