According to new research from Boring Money, Inheritance Tax (IHT) planning is the number one reason for seeing a financial adviser, beating purchasing a property and retiring into second and third place respectively.  The report says ‘Inheritance tax and funds/investments were the two topics most likely to unnerve people; 45 per cent of respondents said they were very uncomfortable with both ideas.'

Indeed, according to financial adviser search engine unbiased.co.uk, the UK is overwhelmingly wasteful when it comes to IHT.

In its TaxAction 2016 report, sponsored by Prudential, Unbiased estimates 'the UK could have saved around £595 million more through some simple estate planning'. This accounts for 13 per cent of the UK's total for unnecessarily paid tax, which stands at £4.6 billion in 2016.

The report adds: 'For many families, IHT savings could be achieved by the simple measure of ensuring that life insurance pays into trust, not into the deceased's estate.'

Big IHT bills happen because of the way people tend to see inheritance: as a single, sudden event, but there’s no reason why it has to be that way. We all know we will die one day, and in later life we know the date may not be too far off. It makes financial sense to start the inheritance process before death and to take a step-by-step approach.

Giving it away

There are a number of ways to reduce the value of a taxable estate before death, and so reduce or even eliminate the IHT bill. For instance, gifts covered by the £3,000 annual gift exemption, donations to charities and donations to political parties represented in the House of Commons are not included the taxable estate.

The problem is, small gifts like those described above may not significantly reduce the size of an estate. For larger gifts over the annual exemption, the ‘seven-year rule’ applies.

Most gifts over the annual exemption are known as ‘potentially exempt transfers’ (PETs). If you die within three years of making such a gift, the recipient will have to pay the full 40 per cent IHT on it. The amount reduces year by year from that point, falling to zero if the donor lives for seven years or longer after making the gift.

Reasons to be cautious

Care needs to be taken to ensure that gifts are genuine (outright) gifts. If the donor continues to derive benefit from a gift, then the whole sum may still be counted as part of their estate.

Even if a person were to sell their home early and give the money to their children (as Ronnie Corbett did in 2003) it may not always be in their best interests. If the property were to increase significantly in value, as often happens, then it might be better to keep it regardless of the IHT bill.

If you make large lifetime gifts, the beneficiaries could take out life insurance against the potential inheritance tax bill. Most gifts into trust are now subject to inheritance tax even if made during your lifetime, but this is an area where specialist advice would be needed.

Finally, inheritance tax planning is important, but equally important is to make sure that the person doing the planning should have financial security in old age. There is no point sacrificing everything just to plan for someone else’s future. Advice on planning for the cost of care should also be sought.