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Last Updated: Monday, 15 December, 2003, 13:44 GMT
Inheritance tax
Gifts can be liable for tax

To many people inheritance tax (IHT) is one of those obscure taxes that only the really rich have to worry about.

It's not even a huge earner for the government - it brings in about 2.5bn a year, which is about 0.6% of total tax revenue.

But as house prices continue to rise, a lot of us could be in for a shock when we realise how wealthy we are, on paper at least.

More and more people are having to factor inheritance tax (IHT) into their financial planning.

This is just a guide to inheritance tax. It is not intended to be comprehensive - for serious IHT planning, you should take professional advice.

What is inheritance tax?

In a nutshell, it's a tax levied on an individual's estate when they die.

When we talk about an estate we mean the value of all the possessions they leave behind, including everything from cash, to shares, to the house and its furnishings.

And for the purposes of IHT calculation it can also include gifts made during a person's lifetime.

For the tax year 2005/06) IHT is charged at a rate of 40% after the first 275,000 (which isn't taxed) of an individual's estate. This will rise to 285,000 next year and then to 300,000.

If you think your estate will be worth more than this then you can plan ahead to reduce the IHT bill left to your dependants.

What should I do?

One of the most important steps is to make a will.

Although this won't reduce IHT by itself, it makes sure your assets go where you want them to.

That might help reduce IHT bills for the beneficiaries of a the estate.

There are DIY will kits around, but you might need to take professional advice for anything not entirely straightforward.

Aside from making a will, there are other ways you can avoid leaving an IHT bill or at least reducing it.


Gifts made during a person's lifetime are known as Potentially Exempt Transfers (Pets). A Pet (sounds cute doesn't it) made seven years or more before the death of the person who gave it becomes an exempt transfer (i.e. you pay no IHT).

If death occurs within seven years, the Pet gets caught up in the estate. If the total value of Pets and assets exceeds 275,000, IHT is payable.

There is taper relief on Pets; that means the rate decreases the further away from death the gift was made.

"I want to give away the holiday cottage to the kids but I want to keep using it from time to time."

Be careful, because if you give something away but keep the right to use it, that won't be considered a gift for IHT purposes and the asset will still be in your estate.

For example, if you have a valuable vintage car, you could transfer ownership to your son but continue to keep it in your own garage and drive it frequently. In this case the Inland Revenue won't count it as a gift.


As well as gifts there are some exemptions you can use to try to reduce an inheritance tax bill.

Some work only during your lifetime, others are available on death.

Things you can do while you are alive.

  • You can give away (transfer) up to 3,000 a year and this will be exempt from IHT.

  • Gifts made regularly out of income earned in the course of each year are exempt from IHT, providing they do not affect the donor's usual standard of living.

    There's no upper limit on this, just what your income will support.

  • You can also give small gifts of up to 250 per person per year, and various marriage gifts.

  • You can gift money or assets to your children or dependants as long as it is for their general upbringing and support.

    Once you have departed

    There are also a number of options available to you (well, really your dependents) after you have passed away.

  • Spouse exemption - transfers from husband to wife, and vice versa, before or on death, are exempt from IHT.

    The simplest way of eliminating IHT is to leave everything to your spouse - but bear in mind that this may lead to a big IHT bill when your spouse dies.

  • And lastly gifts and bequests to charities, political parties and organisations like universities and museums are also exempt.

    This information is not intended to be definitive and should be used for guidance only. Always seek professional advice for your own particular situation.

    Inheritance tax
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