‘I’m 80, with no children and a £1m estate. Why must our family pay so much inheritance tax?’

Would you like a Telegraph Money Makeover? Apply here or through the form at the bottom of the page

Inheritance tax is fiendishly complicated. With a long list of exemptions, allowances and family rules, thousands struggle to navigate the hated death duty each year – and for families who do not fit a traditional template, it often means handing more money over to the taxman.

This is the dilemma facing Harry Orchard, an 80-year-old reader from Derby. He and his wife have no children, but want to pass on their estate, worth just over £1m, to their nieces and nephews.

Yet inheritance tax rules mean the couple cannot pass down as much to their family, thanks to an allowance that only applies to “direct descendants”.

“But my big question is about what to do about our bungalow,” Mr Orchard said. “My sister’s partner passed away 20 months ago, and at the time they were registered as proprietors in common. Her partner left his half of the property to his son – but as he lived far away, and I have recently sold my business, I purchased this from him.

“Now my sister and I both own half of the property. She has two sons who she will leave her half to, but my wife and I want to leave our half to other nieces and nephews. What does this mean for us? How much inheritance tax will they have to pay?”

Overall, the bungalow is worth around £440,000. Mr Orchard’s own home is worth £200,000, and he has two rental properties worth £100,000 each. He has investments worth £37,000, and savings across multiple accounts worth around £363,000.

“My sister is 87. We are both in good health, but we want to plan for the inevitable.”

Andy Butcher, chartered financial planner at Raymond James

If Mr Orchard wants to pass on his share of the bungalow to his nieces and nephews upon his death, this will only use part of his nil-rate band, so there will be no immediate inheritance tax due. If the remainder of his estate then passes to his surviving wife, there will be no further inheritance tax due until his wife’s death.

When she passes away, her executors can claim the remainder of Mr Orchard’s nil-rate band, £105,000, as well as Mrs Orchard’s nil-rate band, giving an overall tax free allowance of £430,000.

In this scenario, it means Mrs Orchard’s taxable estate would have a value of £369,545, which would trigger an inheritance tax bill of more than £140,000.

Unfortunately, as Mr and Mrs Orchard have no children, their home does not qualify for the additional residential nil-rate band, which would have given them an extra £350,000 combined to pass on tax-free.

If, however, Mr Orchard’s wife passes away before him and all of the assets are in his name on his eventual death, the property will be bequeathed as per his will to his nieces, but the inheritance tax position is a little more complicated.

As all of the assets are now being left to people other than his spouse, Mr Orchard’s executors will need to calculate the available nil-rate band.

Overall, the inheritance tax due will be the same, but the will usually dictates how the estate is split. It can stipulate the property left to the nieces and nephews is left free from inheritance tax, meaning the property is passed without liability and inheritance tax due is paid using the remainder of the assets in the estate.

In terms of reducing this tax liability, a lot depends on Mr Orchard’s risk appetite. It could be as simple as gifting assets to his nieces and nephews, but this would mean he needs to survive for another full seven years for the gifts to be exempt.

He could invest in shares in London’s junior stock market, also known as “Aim”. Many of the shares in this market qualify for business relief if they are held for at least two years before the date of death, but they are higher risk, so may not be appropriate at Mr Orchard’s age.

As such, he may want to consider a business relief fund or portfolio service – these can be lower risk options which invest his money into other businesses that also qualify for business relief.

Some services also offer an insurance plan, so if Mr Orchard dies within the initial two year period before the money is exempt, the insurance pays the inheritance tax due on the investment value. Meanwhile, he can access the assets if he needs to draw on them.

Mr Orchard could then also set up a business relief trust in his will and name his wife as a  beneficiary. This way, if he passes away first, his wife can borrow from the trust if she needs funds during her lifetime without adding more value to her taxable estate.

Lisa Caplan, chartered financial planner at Charles Stanley

The size of the inheritance tax bill in this case depends on how Mr Orchard and his wife set up their wills. But assuming they first leave everything to each other before passing on assets to anyone else, the inheritance tax bill on their estate will be more than £140,000.

A deed of variation could reduce the inheritance tax bill. As Mr Orchard’s sister’s partner died less than two years ago, he can look into arranging a deed of variation on the will.

He will need a solicitor for this, and it is complicated by the fact that he purchased the son’s half of the property, but a solicitor would be able to guide him.

The variation would need the agreement of all of the beneficiaries and the executors. Mr Orchard himself does not need to be a named beneficiary of the will. The time limit is two years, but if this worked, it could significantly reduce the inheritance tax on Mr Orchard’s estate.

Mr Orchard has multiple sources of income, so if he finds that he has more than he needs, he can give the excess away – but it must be planned carefully.

In order to qualify as exempt from inheritance tax, his executors will need to demonstrate that the income was truly unneeded. This applies only to gifts from income. Capital such as cash in the bank does not apply.

He must also survive for a full seven years after each gift. If he does not, the assets are included in the inheritance tax calculation. The rate will start to taper off after three years, but the gift will count against his £325,000 nil-rate band (or combined £650,000 allowance with his wife) for the full seven years.

Official life expectancy data suggests that Mr Orchard could live to 90 – he can also look into buying term-life cover for the seven years, but that is difficult to source and can be expensive for a man of his age.

Another issue to be wary of is that gifts may trigger a capital gains tax charge. If Mr Orchard owns the assets on death, capital gains tax does not apply.

Gifts also need to be genuine and he cannot retain any rights – for example, if he wants to give away one of his rental properties, he cannot continue to receive rental income.

At the moment, Mr Orchard’s share portfolio includes three Aim shares which could be exempt from inheritance tax: AFC Energy, Ceres Power and ITM Power.

He might consider increasing his allocation to Aim shares, but should be aware they are higher risk and are less liquid than shares listed on the main stock exchange, which means they tend to fall faster and further.