Inheritance Tax

Inheritance Tax*

Did you know that your beneficiaries would become liable for Inheritance tax (IHT) when your estate totals only £325,000 and that everything over that figure is taxed at 40%?

Recent Changes

In October 2007, the Chancellor of the Exchequer announced in his Pre-Budget Statement that an unused 'nil rate band' could be transferred from one spouse or civil partner to another. One positive feature of this change is that it applies retrospectively.

Dividing your estate between yourself and your spouse (or civil partner) – a traditional way of dealing with this tax – only defers the day that your heirs will have to pay the tax, and increases the amount payable on your spouse or civil partner's death.

But there are ways in which your IHT liability can be permanently reduced, or even eliminated.

Inheritance tax is often described as a voluntary tax because of the many steps that can be taken to avoid it. Yet it continues to pose a threat to the continued wealth of many people and their offspring.

Even though part of your estate is exempt from the tax, it is likely that the value of your house alone will exceed the exemption level. This will create a tax liability, which could necessitate the sale of your house just to meet that liability. However, you can counter or reduce your IHT liability by careful planning.

Four myths about death and IHT

My partner will inherit everything
UK law only recognises an unmarried partner if you have made a will. If you are not married and you have not made a will your partner may not be entitled to inherit anything.
The government will allocate my estate fairly
Dying without a valid will is called “dying intestate”. The government has a very restrictive and pre-determined list of beneficiaries and doesn’t recognise unmarried partners, friends and charities. In fact if you die intestate without any recognised beneficiaries all of your estate goes to the Crown.
I will ‘gift’ my house to my children
If you gift your house to your children or grandchildren but remain living in your home – without paying market rent – under UK tax legislation you will be deemed to have made a ‘gift with reservation’ and the full value of your house will be charged to your estate. Even if you do gift your house, without reservation, to your children your estate may still face a tax charge if you die within seven years of making the gift.
I will give away everything just before I die
Under UK tax legislation, any gifts above £3,000 per year will be included within your estate if you die within seven years of making the gift. There is a sliding-scale charge applied over the seven years but if you die within the first two years of making the gift, 100% will still be charged to your estate.

Making a will

A will is the most obvious way to plan for the future and the fairest way to provide for your loved ones. Even if you have made a will, and amazingly 70% of the UK population do not have a will, it is important to keep it up to date. Getting married or divorced can invalidate a will and it can be challenged and changed after your death.

I need help!

Make an appointment with us and we will guide you through the options available to you to protect you and your dependents from an inheritance tax bill.

Estate planning

Providing for your spouse/partner, children, grandchildren and other beneficiaries after your death is one of the most important tenets of financial planning. Most people think of estate planning as just a way to deal with the IHT problem. However, whilst this tax is a major part of estate planning there are other aspects to consider:

1) Protection of spouse/partner and beneficiaries
2) Inheritance tax
3) Will structure

1) Protection of your spouse/partner and beneficiaries

On your death you will probably want your estate to provide for your spouse/partner and your children. If you do not have a family you may decide to make gifts to charity. Whatever you intend, it is imperative to make a will. To die intestate, can leave your loved ones and beneficiaries in a difficult position. At relatively little cost, a will can save a lot of heartache at a difficult time.

Often, people will leave their entire estate to their spouse/partner. This is very inefficient for IHT purposes. Do you really need to leave all your estate to your spouse/partner? Could your children and other beneficiaries benefit from your estate on first death? Perhaps you could think about more beneficial ways to invest in your extended families’ futures. You could, for example, help with the cost of raising and schooling grandchildren. You might also consider charitable donations.

2) & 3) Inheritance tax and will structure

IHT planning and structuring your will are inextricably linked. For every individual, there is a limit to the amount they can pass on through their will before IHT becomes payable. This limit is referred to as the ‘nil-rate’ band. This tends to increase annually and is presently set at £325,000.

The estate of anyone dying with more than this will be liable to IHT at 40% on the excess. For example, the estate of a single person leaving £400,000 on their death, attracts an IHT charge of (£400,000 less £325,000) x 40% = £30,000.

However, the estate of someone who is married may, at death, avoid IHT by using their ‘nil-rate’ band to pass money to whoever they want with the balance being passed to their spouse (or civil partner). This is because all such transfers of assets between spouses are free of IHT.

However, if all of the estate is passed to the spouse (or civil partner), this in turn will make their estate ‘pregnant’ with an even greater IHT liability possible on their death.

When tax planning for larger estates, the trick is to strike a balance between leaving sufficient wealth for the spouse (or civil partner) whilst using up the ‘nil-rate’ band so as to pass wealth to the children or other selected beneficiaries in a tax-efficient manner.

Will Trusts

Using a Will Trust can provide more flexibility. Put simply, on death, the children’s share of the estate – up to the maximum “nil-rate” band applicable – passes into a discretionary trust where the beneficiaries are the widow/er, the children and any other person thought appropriate.

The trustees are the widow/er and any other person, say a family friend, but not a beneficiary. Depending on the circumstances at the time, funds may be passed to the children (or any other beneficiary) in any proportion as the trustees decide.

If your spouse/partner feels there has been insufficient provision made, he or she may choose to pass money from the trust to him/herself. This can be done to great effect by the trust’s funds being invested in multiple-policy insurance bonds. Typically, these may comprise of 100 or more policies, which may be encashed for the benefit of the stated beneficiaries.

The situation is of course reversible, with Will Trusts being used to plan for IHT on first death.

Deed of Variation

Under present legislation it is possible, for a period of up to two years from the date of death, to utilise a Deed of Variation to achieve the same effect as a Will Trust. This method has come under attack by previous governments and we prefer the Trust route. The Deed Of Variation has another disadvantage, in that all beneficiaries must be in agreement.

It is of course possible to mitigate and plan for IHT during your lifetime and there are a number of options open to you.

Potentially Exempt Transfers (PETs)

Irrevocable gifts made during an individual’s lifetime may, providing certain conditions are satisfied, be classed as a PET. These gifts only become exempt providing the donor survives seven years. If death occurs within seven years the PET becomes a chargeable transfer. The amount of tax will depend upon the rates payable at the time will apply. The donee will be liable for the tax.

To qualify as a PET a gift must be made to:

a) An individual
b) A trust in which an individual has an interest in possession
c) A trust for the disabled
d) An accumulation and maintenance trust.

The gift will not be a PET if there is any form of reserved benefit in the gift. Using a PET you could therefore reduce the value of your estate while you are alive. In reality only the wealthiest of individuals can do this, as most people will need their capital in retirement.

Life Assurance

IHT mitigation is difficult for many people simply because of the need for capital in retirement. A large number of people prefer to insure themselves so that on death there is a substantial sum available for the beneficiaries to meet the IHT liability.

Typically, a couple would take out a Last Survivor Whole of Life Assurance. This policy would be written in trust for their beneficiaries and would be payable to them on second death. Because the policy is placed in trust the proceeds are outside the deceased parents’ estates and therefore not liable to IHT.

The cost of this type of cover is relatively inexpensive, although the cost will depend upon the nature of the contract.

Exempt Transfers

Even if a transfer occurs it will not attract IHT if it is an exempt transfer. Below is a list of exempt transfers.

Gifts to your spouse / civil partner
Normal expenditure out of income
£250 small gifts (to different people)
Annual £3,000 exemption (plus previous year if unused)
Exemption for marriage gifts
Gifts to registered charities
Gifts to political parties
Gifts to housing associations
Certain transfers to employee trusts

*not regulated by the FSA