Inheritance tax (IHT) is a tax payable on the worldwide assets of any UK domiciled individual on their death.

Tax is payable at a rate of 40% of the value of their total estate, less the ‘nil rate band’ (NRB), which is £312,000 in the 2008/2009 tax year.

There are a number of exemptions:

• Where a surviving spouse dies on or after 9 October 2007 the administrators of their estate can make a claim to increase the surviving spouse's NRB by the unused NRB of the first spouse to die.

• Transfers between UK domiciled spouses are totally exempt.

• Each individual can give away up to £3,000 p.a. If the allowance is not fully utilised it can be carried forward to the next tax year but no further and can only be used after the current year’s allowance has been fully utilised.

• Unlimited number of small gifts up to £250 each can be made in a tax year. However, an individual can not receive both the £3,000 allowance plus the £250 small gift.

• Wedding or civil partnership gifts in addition to the annual allowance are exempt up to certain amounts:

• £5,000 to one’s children

• £2,500 to one’s grandchildren

• £1,000 to anyone else

• Regular gifts from post tax income are exempt as long as they do not materially affect the standard of living of the person making the gift. This includes regular premiums on life insurance policies and regular birthday or anniversary gifts.

• Gifts to charities and political parties are exempt.

There must be no strings attached to the gift (technically known as a gift with reservation of benefit). Its value is the loss to the estate, not what the value is to the beneficiary.

Any other gifts not covered by the above exemptions may be either Potentially Exempt Transfers (PETs) or Chargeable Lifetime Transfers (CLTs). There is a significant difference in the way these are taxed.

Chargeable Lifetime Transfers are usually created when a gift above the NRB is made into a discretionary trust ( the beneficiaries are not fixed at the time of giving the gift). These gifts are taxed immediately at the lifetime rate of 20%, rising to 40% if the donor dies within 7 years. There will be further charges on the Trust of 6% every 10 years and on any payments to the beneficiaries.

Potentially Exempt Transfers are transfers of assets to individuals, bare or absolute trusts and trusts for the vulnerable and disabled. There is no tax payable at the time of making the gift and if the donor lives for seven years from the time of making the gift, the gift becomes exempt.

Both PETs and CLTs benefit from taper relief. Taper relief reduces the amount of tax payable on death from the full rate of 40% on a sliding scale over seven years. It does not reduce the value of the estate.

The above is a brief summary of the main features of inheritance tax. There are many ways to reduce the effects of IHT.

Key Financial Services Ltd can help you to choose the best way for you. For a free initial consultation, click on contact us.

The Financial Services Authority does not regulate advice on taxation.