Protect your family from the taxman

After the latest legal blow on liabilities, Kate Hughes looks at ways to pass on as much as possible

If you die and the value of your estate – all your possessions, including your home, its contents, your car and your savings (minus any debts) – is more than £312,000 this tax year, everything you have to leave above that limit could be liable for tax at 40 per cent. This is the grim reality of inheritance tax (IHT).

The Government earns £3.5bn a year from the tax, whose threshold has not kept up with the surge in property prices since the late 1990s. This means that many people who do not consider themselves rich face the prospect of leaving their loved ones a big tax bill after their death.

In a recent concession, the Treasury allowed married couples and civil partners to pool their IHT allowance, so that when one dies, their estate is passed on free of IHT to their partner. When the second person dies, the estate is passed on with the first £624,000 IHT free.

But this leaves thousands of single people still out in the cold. Last week the Burden sisters, Joyce (pictured, left) and Sybil, 90 and 82 respectively, lost their long legal battle to have the same rights as a married couple or civil partnership for IHT purposes. When one of the sisters dies, the surviving sister will have to pay a tax bill running into hundreds of thousands of pounds, forcing her to sell the home the Burdens have shared for many years.

The Burdens' situation may seem heart-rending. But, with a little careful planning, it is still possible for people like them to save a fortune in IHT and even get to leave the family home to their loved ones.

"The first, crucial step is to write a will," says Robert Meyer of trust fund specialists Close Investments. "If you die without one and have no family, everything goes to the Government."

Next, advises Mr Meyer, try to reduce the value of your estate for IHT purposes. Money given to family or friends in your lifetime can fall outside the IHT net, but you have to plan early. If you live for at least seven years after making such a gift, the beneficiaries should not have to pay IHT on it.

Certain other cash gifts – up to £5,000 for a wedding or civil partnership present, all charitable donations and £3,000 given away each year to any individual – are also exempt. And you can make any number of small gifts of £250 or less a year.

"If you don't use your annual allowance, it carries forward for one year only, so you could gift up to £6,000 this year free of IHT," says Julie Hutchison, an estate planning specialist for Standard Life.

A slightly more complicated but effective way of keeping the taxman off your cash is to write your investments and life insurance into trust. This means your money is technically outside your estate and is not IHT liable, "and a trust allows someone to receive a legacy in a controlled way," adds Ms Hutchison. In other words, strings can be attached, so, for example, the recipient may inherit only at a certain age.

IHT is often described as the optional tax: with planning, it can be reduced or even deflected entirely.