Special Report on Peps and Tax Planning: Do not be denied your inheritance: Christine Stopp with hints for couples and families

THE GOOD news, says the taxman, is that 96 per cent of estates do not have to pay inheritance tax. Yet, according to the financial advisers' organisation IFAP, the British public pays out pounds 665m inheritance tax that could have been avoided by advance planning.

The threshold above which you have to pay inheritance tax is pounds 150,000 for deaths after 10 March 1992 (this limit is usually increased in the Budget). If all your assets, including your house, are worth more than this, inheritance tax might be something that should come into your financial plans.

Included in your estate for inheritance tax calculations are gifts you have made within the last seven years before your death. Some gifts are exempt from this ruling (see below). Gifts to charity are normally free of inheritance tax, and so is anything that you leave to your husband or wife.

Funeral expenses and outstanding bills are deducted before arriving at the taxable amount. The value of your remaining estate - house, car, bank account, investments, other assets - above the pounds 150,000 limit will be taxed at 40 per cent. So, on an estate valued at pounds 175,000, tax of pounds 10,000 - 5.7 per cent of the total - would be paid.

There are a number of ways to go about reducing a potential inheritance tax bill. You can make gifts within the exempt limits to reduce the value of your estate. Non-exempt gifts made more than seven years before your death are not taxed either, so if you have enough money for your own needs, and you intend to leave money to someone in any case, you might as well do it in your lifetime.

If you die at least three years but less than seven years after making the gift the rate of tax may be reduced. Problems occur with this strategy when you need your capital to provide you with an income, or where the heir is too young to be left a large sum outright.

Making the right provisions through a will can make a big difference to the inheritance tax position, since a husband or wife can inherit assets free of tax. Suppose a married couple intend to leave their whole estate of pounds 220,000 to their children. The wife dies, leaving her half share of the estate to her husband. In due course he dies, leaving it all to the children, who incur a tax bill of pounds 28,000 (assuming no growth in the assets).

If the wife left pounds 70,000 directly to her children instead of to her husband there would be no tax to pay and on his death the entire estate would fall within the nil rate band.

Taking this one stage further, the wife could leave some of the money directly to her grandchildren. This avoids adding to the estate of her children. It also means that the grandchildren will be taxed in their own right on income from the money. If they have no other income, there should be no tax bill. If the money is left to the parents and given by them to the children, income on the money will be taxed as the parents' income.

Giving an asset away is not enough on its own: you must renounce any benefit from it. For example, if you put your house in your children's name but go on living in it, there will still be inheritance tax to pay.

There are a number of insurance plans that can be used to help reduce inheritance tax. Some of these are everyday policies. Others are complex plans specially designed to meet inheritance tax problems.

You can take out a whole of life policy - which provides a lump sum on your death - to cover the cost of the tax. This could save your heirs having to sell the family home to meet the tax bill. Any insurance policy can be 'written in trust', which removes it from your estate. Writing a policy in trust simply means naming the person who is to benefit from the policy proceeds.

An annuity will increase your income in retirement and also remove the amount invested from your estate - though the value of a level annuity may be overtaken by inflation if you have to rely on it for a number of years.

A back-to-back plan uses an annuity which produces an income. Part of the income is used to buy a life policy which then builds up a lump sum to cover the eventual tax bill.

There are also more complicated approaches to protecting your estate from inheritance tax, though serious tax planning may only be worthwhile for those with very large estates - say of pounds 300,000 or twice the nil rate band.

GIFTS EXEMPT FROM TAX

Wedding gifts up to pounds 5,000 to your child, pounds 2,500 to your grandchild and pounds 1,000 to anyone else in each tax year.

Most maintenance payments.

Other gifts up to pounds 3,000 in value in any tax year, plus unused balances of pounds 3,000 from the previous tax year.

Gifts in any tax year of up to pounds 250 each to any number of people.

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