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Don’t let your heirs down

My wife and I are concerned about the potential inheritance tax on our estate, which is currently valued at 1.5m. We have three children and want them to benefit as much as possible on our death. What strategy can we adopt to minimise the risk of a big tax bill?

In an era when property inflation has caused many people who would not consider themselves to be rich to realise that inheritance tax is a real threat, you will not be surprised to learn that many people like you are concerned.

Inheritance tax is perhaps the last thing we think of as we go through life and build up assets. Put bluntly, if both you and your wife had died yesterday, then inheritance tax of nearly 495,000 would be payable. This would leave a net estate of 335,000 for each of your three children.

The biggest single beneficiary of your estate would be the Inland Revenue – and I guess that would not be your wish.

In my experience, there is a definite polarisation of opinion on inheritance tax. There are those who state: “I do not want the Inland Revenue to get a penny of my money” and others who say: “My children are going to inherit more than I ever did so let them pay the tax.” Interestingly, many of the former move over to the latter group when they discover the costs of doing anything about it.

But there are some fairly simple and cost-effective measures which you might take which, even if they do not wipe out inheritance tax altogether, will help to mitigate it to some degree.

The first thing to look at is your wills. The chances are that you and your wife have mirror wills, with your estate passing to her on your death and vice versa.

By changing the terms of your wills so that, in the event of either of you dying, the value of the nil-rate band (275,000 in 2005/06) passes down to the children, you save 110,000 potential tax at a stroke. Otherwise, if you die and all your estate passes to your spouse, your nil-rate band is effectively lost.

See a solicitor and have your wills amended to include a nil-rate band trust.

If you have any life insurance or even a pension fund, it is worth checking to see if the death benefits are written under trust. In the event that they are, then on your death the proceeds might be payable to the beneficiaries without the monies ever forming part of your estate.

If you have death benefits as a result of employment, check to see what the practice is of the trustees. Will they pay the proceeds to the legal personal representatives of your estate in order to get an adequate discharge of their responsibilities? If they do, this is inefficient from the point of view of inheritance tax.

One simplistic method of dealing with inheritance tax is to consider insuring against it. You and you wife might buy a whole-of-life policy where the sum assured is payable on the death of the second of you to die. The policy proceeds might be subject to a trust, with your children as the beneficiaries. The sum assured should be set at the level of the inheritance tax that might be payable, remembering to take future inflation into account.

In the event of the two of you dying, the children will have sufficient money available to pay the tax bill. Bear in mind that it is the children who benefit here. If they are in gainful employment, my advice to you is to get them to reimburse you with the premiums.

Of course, if you are quite well off and have liquid resources, one way of reducing the value of your estate is to give some of it away while you are living. Gifts to the children made during your lifetime will escape the inheritance tax net as long as you live for at least seven years after you have made them.

I guess this is the acid test. Do you hate the thought of the taxman getting more of your estate on your death more or less than the thought of what the little darlings will do with any money you give them while you are alive?

Inheritance tax is a complicated tax and there are a number of more complex ways of dealing with it than I have outlined here. Do get a full and detailed analysis carried out by your financial adviser.

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