Act now to stop taxman inheriting your fortune

Through the roof: property price rises mean many homes in Scotland are worth more than the £285,000 nil rate inheritance tax band. Photograph: Phil Wilkinson

SCOTTISH house prices are up 14.5% compared with a year ago, according to the latest figures from Britain's biggest mortgage lender the Halifax, pushing thousands more home owners into the inheritance tax bracket.

Property inflation north of the Border is running at twice the levels of most of the rest of England and Wales, where only in Greater London and East Anglia are seeing annual price hikes as high as 8%.

Many homes in Scotland will now be worth more than the £285,000 nil rate inheritance tax band, after which the government takes 40% of anything left after a death in the family.

But with careful planning it is possible to ensure that the modest wealth you have built up over a lifetime is passed intact to the next generation.

It is not paying the tax that many object to. As Scotland on Sunday reader John Groves of Edinburgh said: "I'm sure I won't care when I am gone whether I pay tax or not. What would annoy me, though, is if I paid tax which lots of other people escaped."

Financial advisers Origen will this week publish a 10-point plan aimed at mitigating inheritance tax bills. It will highlight the key areas anyone thinking about the future should consider. Drawing up a will and structuring your estate is vital. If you organise your affairs properly, a couple can shelter £570,000 from the taxman.

After that, Origen's Bob Perkins argues: "For most ordinary people there are only three options: you either give your assets away, spend your money or pay the tax."

1) Make a will

The most important first step is to make a will. Find a good solicitor who can also give trust advice where appropriate. Where your arrangements are complex, you may need to consult a financial adviser or tax planner as well.

2) Dividing wealth carefully in life can save tax on death

It is vital unmarried couples, married couples and those in civil partnerships arrange their affairs to protect their other half.

For example, if your partner dies and you are not married, then you could face a bill for IHT for his or her share of your home and other possessions. You could even be forced to sell the property to find the money.

Unmarried couples must also take a close look at their life assurance arrangements. A big payout on death will be liable for IHT unless it is written in trust. Combined with the tax due on the house, the surviving partner can be left in dire straits. If in doubt, speak to your insurer.

Married couples and those in civil partnerships, on the other hand, can leave all their worldly goods to their beloved on death without incurring any IHT. However, there may be circumstances where you don't wish to do this, as your IHT nil-rate band will be lost and the subsequent tax bill considerably higher.

Husbands and wives must also keep an eye on life assurance. Traditionally they bought joint life policies, which simply carry on after one partner dies. However, because of the increase in divorce and the difficulties with unravelling contracts, this is less common today. So again, make sure any protection is written in trust. This also applies to pension investments, although these will typically be written in trust in any event.

3) Maximising the tax bands

To keep it simple, two tax-free bands are better than one. If your combined wealth amounts to £570,000 when you die, and you leave your share to your wife, when she dies, there will be £114,000 tax to pay. (40% of £570,000 minus £285,000).

However, if you give your £285,000 share to your children and your wife does the same when she dies, the entire £570,000 passes to the next generation tax-free. To achieve this, assets must be held in your separate names.

Ideally, this works best where the wife, say, can keep the house and the children receive investments or other assets and possessions which can easily be handed on by their father should he die first.

In many cases, though, most wealth is tied up in the house, and when it comes to property the situation is more complex. Again couples may wish to leave their share of the house to the next generation individually, in which case they must think carefully about whether they want a "survivorship" clause.

Under Scottish law, a home automatically reverts to the surviving spouse if there is a survivorship clause. However, if your joint wealth will push you into IHT you may be better off without one. This will allow the property to be passed on elsewhere, according to the will.

Solicitor Richard Loudon of Simpson & Marwick said: "Where the house is clearly below the IHT thresholds we usually recommend a survivorship clause. The house can then be passed simply and at low cost to, say, a widow after her husband dies. But where a couple has considerable assets, this is probably not a good idea."

There are dangers in passing half the property on to the next generation, because that leaves the widow or widower relying on the children's goodwill to allow them to continue living there rent-free.

Should their sons or daughters get involved in divorce, face bankruptcy or other financial difficulties, your home could be sold to meet their bills elsewhere.

4) How to pass your assets to the next generation tax-free

You can hand big items, including your home, tax-free to your children, but only if you survive for seven years. Such gifts must be made without reservation. This means you give them absolutely and do not continue to benefit from them.

You cannot, for example, give away your house and continue to live in it, unless you pay a commercial rent.

Remember, giving your home away to someone else, even a beloved son or daughter, is a very high risk activity. You may be able to trust your children, but others can have claim on their assets, which will include your home.

5) Be generous

Don't forget that your building society savings and other investments will be included in your estate and possibly taxed at 40%. If you can afford to, it can make sense to think about giving some of this away. However, there are rules about how much you can give and when, so you must take care to avoid being taxed even here. You can give away £3,000 in total each year, and not be liable to IHT.

You can also give away up to £250 to as many people as you like, and make special gifts to close relatives on marriage.

6) The super wealthy

If, as you get older, you are fortunate enough to go on enjoying substantial income that you simply do not need to live, you can give this away tax-free, provided your capital is intact and you do not adjust your living standards. Some extremely wealthy individuals resent paying 40% tax later in life, with the prospect of a further 40% IHT hit in immediate prospect.

7) Deeds of variation

When there is a death in the family, take a close look at whether the deceased's affairs couldn't have been better arranged via a "deed of variation". These can be used to override a will, provided the beneficiaries are all in agreement.

8) Skip a generation

It can make sense for grandparents to make bequests straight to their grandchildren. For example, if grandma leaves her house to her son, who himself is already in his 40s or 50s with property and an IHT liability of his own, she is merely compounding his tax problems.

If he hands it straight to on to his children, they will have to wait seven years before it is free from tax.

However, if grandma leaves it straight to the children, there may be no tax to pay, and no seven-year wait.

9) Keep an eye on business

"Qualifying business property" can attract IHT relief. This includes companies quoted on AIM.

10) Review arrangements

Circumstances, asset values and tax regimes change. Do not consider making a will a once-in-a-lifetime event. Keep your arrangements up to date.