Inheritance Tax (IHT) is paid on your estate when you die and also when money is transferred into some trust funds. Some other transfers during one’s lifetime may also be subject to IHT. The first £325,000 (at 2012/13 rates) of the estate is exempt from IHT. This is called the nil rate band. The assets in the estate are valued on death, the nil rate band subtracted and the remainder of the estate is taxed at 40 per cent. Chargeable lifetime transfers are taxed at 20 per cent. Transfers made within seven years of death which are brought back into the value of the estate for IHT purposes are charged at 40 per cent.

Where one spouse transfers part of their estate to the surviving spouse or civil partner, the percentage of the 'tax free' transfer is calculated and the remaining percentage is then used to uplift the tax free amount on the second spouse or civil partner's death. How this works is not straightforward, but potentially allows a 'double IHT free limit' to be enjoyed.

IHT used to concern only the wealthy. Nowadays, however, more and more people find themselves within its ambit.

There are exemptions from IHT for the following:

• property transfers between spouses or civil partners (not between unmarried partners);
• gifts to institutions such as the National Trust, charities and political parties; and
• gifts in consideration of marriage or civil partnership (within permitted limits), annual gifts to the value of £250 to anyone and gifts which are part of normal household expenditure (such as birthdays).

You are also allowed to give away up to £3,000 per annum. This allowance can be carried forward to the next year, if not used in a tax year. The carry forward is for one year only.

Gifts made ‘out of income’ are also excluded. These must be of a scale that does not affect the lifestyle of the donor and must normally be regular – an example might be school fees paid by a grandparent. These must be justifiable. There is evidence that HM Revenue and Customs are looking more carefully at these and seeking to disallow them when possible, so, for example, setting up a standing order to transfer regular smaller sums may be preferable to less frequent, larger transfers.

What Can be Done to Reduce IHT Liability?

• Potentially Exempt Transfers (PETs). The general rule is that a gift will normally cease to be part of a person’s estate if they survive seven years after making it. If they die within seven years, then the IHT to be paid will be reduced on a sliding scale depending on the time interval between the making of the gift and the death of the donor. (Note: the reality is more complex than this, and in some circumstances a gift may be caught if made longer then seven years previously).
• Equity Release. An Equity Release Scheme (of which there are several types) allows money locked in freeholds to be released. This can be given away as a PET and if the donor survives more than seven years then it will not normally attract an IHT liability.
• Life Assurance. Policies are available which may pay all or some of your IHT liability. These can be written in such a way that they pass directly to your family and do not become part of your taxable estate. Lump-sums payable on the death of a pension policy holder can also normally be arranged to fall outside your estate.
• Holding Exempt Assets. Certain assets (such as shares in AIM-listed companies and in family businesses) are wholly or partially exempt from IHT if certain conditions are met.
• Trust Funds. Setting up a trust fund used to be a common way to leave money. This can be an effective way of minimising the impact of IHT. However, changes made in the Finance Act 2006 have made some of these less attractive. If you have established such a trust or are thinking of doing so, it is sensible to seek professional advice.