How to give away a £4m estate and pay no inheritance tax

Former Chancellor Nigel Lawson once described inheritance tax as a “voluntary tax”. This is because, with careful planning, it is possible to dramatically cut your tax liability, even for very large estates. 

Bereaved families are currently paying more death duties than ever before due to the Government’s freeze on tax thresholds. Inheritance tax cost families a record £7.1bn in death duties last year, and the tax take is predicted to soar over the next five years while the bands remain unchanged. 

If it looks like your family could face an inheritance tax liability, taking action soon is advisable in order to avoid the 40pc charge. 

You will only pay inheritance tax if the value of your estate upon death exceeds the nil-rate band of £325,000. Homeowners get an additional allowance called the residence nil-rate band – worth £175,000 – and if you are married, you can share your allowances, sheltering a total £1m from the taxman. 

However, if your home is worth more than £2m, then the residence nil-rate band will start to taper by £1 for every £2 over the taper threshold.

To demonstrate how a fairly large estate containing a high-value property can sidestep death duties, we are going to walk you through how a married couple – both 70-years-old – with a £3m property and £1m in cash could bring their inheritance tax bill down from £1.34m to £0. 

Step one: set up a discounted trust

There are various gifting allowances that everyone can use to reduce the size of their estate. For example, you can give away £3,000 a year tax-free, regardless of how long you survive after giving the gift. You can give away larger gifts of any size, but you’ll have to survive the gift by seven years in order for it to be free from inheritance tax. 

These allowances could help the couple syphon off their £1m in cash savings, in order to cut their inheritance tax liability. But there are clear disadvantages to giving away hundreds of thousands of pounds in a short space of time. For example, what if the beneficiaries are not yet ready to receive an early inheritance? 

Lucy Chahil, of the wealth manager Charles Stanley, said: “One option would be to place up to £650,000 of the cash into an inheritance tax product, such as a joint discounted gift trust, without any immediate tax charge.”

If a value that exceeds the nil-rate band – £325,000 for an individual and £650,000 for a couple – is placed into a trust, then a 20pc tax charge may apply. 

“Regular fixed payments can be taken, and it is important to set the right level as this cannot be changed once set up,” Ms Chahil said. 

“The gift into trust will provide an immediate IHT saving, based on the discount applied (determined by life expectancy and likely total payments), and the whole gift will be free from inheritance tax after seven years.”

Bear in mind that when you set up a trust, you must keep a record of gifts made within the seven years prior, as these could affect the inheritance tax liability and an adviser’s planning recommendations. 

Step two: downsize the property

Ms Chahil’s next recommendation is that the couple downsize in order to bring their property below the £2m threshold, making them eligible for the residence nil-rate band (provided they leave the home to a direct descendant). 

She said: “If the couple were to opt to downsize and purchase a new home for, say, £1m, this could release around £1.95m in capital after moving costs, including £41,250 for stamp duty. 

“Depending on their income requirements after establishing the discounted gift trust, this capital could be spent, gifted or invested in investments that qualify for business relief as appropriate.”

The result, based on current rules and legislation, is that after seven years the couple could reduce their inheritance tax bill to £180,000 – compared to £1.34m if no action was taken. 

Step three: give away remaining money 

At this point £450,000 of the couple’s estate is now subject to inheritance tax. They may decide it is better to hold on to the savings and risk a £180,000 inheritance tax charge.

But, if they want to completely get rid of their estate’s liability, there are a number of options available to them. “These could include further outright gifting, or investing in assets that qualify for business relief, which receive 100pc relief from IHT once held for two years,” Ms Chahil said.

Investing in qualifying stocks and shares listed on the Alternative Investment Market (AIM) is risky, however, as the investment could fall as well as rise in value. 

Gifting the money to beneficiaries may be safer, but this would need to be done outside the seven-year timeframe to prevent an inheritance tax charge.