How can I cut my inheritance tax liabilities before I die?

I am in my 70s and want to ensure that I mitigate any inheritance tax bills when I die. 

I am widowed and have three children, all married, and four grandchildren, aged between five and 14. Can you give me any good advice? M.B., Cardiff 

Ruth Jackson-Kirby replies: Inheritance tax, payable upon death, is a growing worry for many people. The inheritance tax threshold – above which tax is charged at 40 per cent – has been frozen at £325,000 since 2009 and will remain the same until at least 2026. 

As house prices and inflation rise, an increasing number of estates are becoming liable for the hated death duty. 

Not that the Government minds. Her Majesty’s Revenue & Customs is enjoying record-breaking IHT receipts with £6.1billion received in the tax year ending April 5, 2020, the latest statistics available. This is up 14 per cent on the previous year. The average IHT bill is now £216,000. 

That’s the bad news. The good news is that there are many actions you can take to minimise any future IHT bill and ensure you pass as much of your estate as possible to your family. 

First, let’s look at the allowances available. As mentioned, the first £325,000 of your estate – the value of everything you own from savings to paintings – can be passed on free of IHT. 

You can also pass on a further £175,000 tax-free if you leave your main home to your children or grandchildren. 

You mention that you are widowed. If your spouse left their estate to you, then the benefit of any of their IHT allowance that they didn’t use goes to you. That means you could be able to pass a total of up to £1million to your beneficiaries without being liable for IHT. 

Now let’s consider your investments. If you have money invested in a defined contribution or money purchase pension, it is usually free of IHT and can be passed on tax-free to your beneficiaries if you die before the age 75. 

If you die after age 75, any money subsequently withdrawn from the pension pot by the beneficiary is taxed as income. 

Tom Selby, head of retirement policy at wealth manager AJ Bell, says: ‘Pensions are among the most tax-efficient vehicles available to savers. It often makes sense to spend your pension last if minimising IHT is a priority. Isas and investments held outside tax wrappers usually count towards your estate for IHT purposes.’ 

You can give money away before you die. It won’t be included in your estate for IHT consideration if you abide by the rules. You can give away up to £3,000 a year this way. You may also make annual small gifts of £250 to as many people as you wish – for example, £250 to each of your four grandchildren. 

Indeed, if the grandchildren get married, you can give them each a gift of up to £2,500 – free from IHT. 

Gifts from regular income are also permitted. Sarah Coles, senior personal finance analyst at wealth manager Hargreaves Lansdown, says: ‘As long as it isn’t from your savings or investments, and by giving the income away you’re not affecting your standard of living, you can make a gift of any size which leave your estate immediately.’ 

One sensible option would be to set up monthly direct debits into a tax-friendly Junior Isa for each of your grandchildren, so they will have a lump sum to help them get started in their adult life. 

Any other gifts you wish to make are classed as potentially exempt transfers. This means that if you live for seven years after handing the money over, it isn’t counted as part of your estate. If you die before then, the gift is subject to IHT on a sliding scale, starting at 40 per cent.

It is possible to take out insurance to protect gifts from future IHT. These policies are known as ‘inter vivos’ insurance and will cover any future IHT on the gifted amount. However, they have to be handled carefully. You need to place the policy into a trust – otherwise the payout could be added to your estate and IHT owed on it, increasing rather than reducing your IHT bill. 

Finally, be careful not to overly focus on mitigating IHT. It’s important not to give away too much too soon. People often mistakenly prioritise inheritance tax planning over more important issues such as the funding of any long-term care they may require further down the road.