Inheritance Tax Planning
How does Inheritance Tax Work?
Inheritance tax (IHT) is a tax on capital. It is levied, at the rate of 40%, on any assets currently in excess of £312,000, that you leave to your heirs (other than your UK domiciled spouse) or certain charities.
Many people believe that IHT only concerns the very wealthy. Nothing could be further from the truth. Property prices in the south east are still at a level where the value of your home alone means your estate can easily exceed the above threshold.
Moreover some (if not all) of the IHT bill normally has to be paid, in cash, to HM Revenue and Customs within six months of your death. It must also be paid before your executors can obtain probate and begin to pass assets to the beneficiaries. This often means that an expensive bank loan must be obtained, another cost to your heirs.
What action can be taken to reduce this tax?
1. Make or review your Will
Firstly, if you have not already done so, you should make a Will. Recent research has suggested that as many as two thirds of all UK based adults have yet to make a Will. Quite apart from the other advantages in so doing, you may be able to significantly reduce the potential IHT bill for those you leave behind.
2. Review asset ownership
It can make IHT planning sense for a husband and wife or civil partners, for example, to divide their assets between them so as to 'equalise', at least in part, their estates. In that way, and with appropriately worded Wills, the assets of each can benefit from taking advantage of the current IHT threshold of £312,000 each.
3. Give away assets that can only pay out on death
It is sometimes possible to rearrange life and pension policies so that certain payments on death automatically fall outside your taxable estate. In effect, you are giving away monies that will only pay out on your death with a view to protecting them from IHT.
4. Other lifetime gifts
If, for example, you have earmarked certain assets for your children, giving those assets now may reduce (if not avoid altogether) an IHT liability in the future.
However to be IHT effective gifts must be made absolutely and irrevocably and if you die within seven years of the gift your beneficiaries will still be liable for all or some of the IHT. If you die within three years of making a gift, 40% IHT is payable on the value of what was given away, to the extent that that value of the gift exceeds the available IHT threshold of, currently, £312,000. On gifts made between three and seven years before death a proportion of that IHT liability is payable, on a reducing basis for each year that passes.
5. Exemptions
There are, however, a number of exemptions of which advantage may be taken:
• The spouse exemption: A gift to your UK domiciled/deemed domiciled husband or wife, whether during your lifetime or on death, is exempt for IHT, and is a device widely used in estate planning.
• The annual exemption: The first £3,000 of lifetime gifts made in any one tax year is exempt.
• The marriage exemption: Gifts on marriage of up to £5,000 to any one child by each parent are exempt, as are smaller sums to others, such as grandchildren.
• Other exemptions: Certain gifts to charities, gifts for national purposes (such as the National Trust), gifts for the national benefit and gifts to the main political parties are also exempt, as are certain small gifts and what is known as normal expenditure out of income.
6. Reliefs
There are in addition two main forms of 'relief' from IHT. The first is Agricultural Property Relief, relating to gifts of qualifying agricultural property, and the second is Business Property Relief, relating to gifts of qualifying business assets and interests. These reliefs vary from 50% to 100% and action can be taken to maximise their availability.
7. Using trusts
Trusts have been used for hundreds of years as an effective way of passing down a family's wealth. For these purposes, a trust is a way of making a gift whilst retaining some control over it. Many people are keen to remove assets from their estates but are reluctant to hand over large sums to their heirs unless they have adequate protection.
This can be achieved by the creation of the correct type of bespoke lifetime or Will trust, such as a discretionary trust. Warners are able to advise on the most appropriate form, and the IHT, capital gains tax and income tax implications of creating such a trust.
8. Life assurance policies and products
Another possibility is to estimate, as best one can, the potential liability to IHT, and then take out a life assurance policy to cover it. Insurance products can also be used to provide an 'income' whilst protecting certain capital from a future charge to IHT.
9. Securing any transferable IHT threshold
Under proposals first introduced in the 9 October 2007 Pre-Budget Report if a spouse died without utillising their IHT free allowance this unused allowance can, in some circumstances, be transferred to the surviving spouse. Warners can help advise on what is needed to secure this transfer.
In summary
At Warners our experience and independent advice enables us to guide our clients through the various complexities of capital taxes planning in general, and IHT in particular.
We can advise on the interaction of the various taxes that need to be considered (including Stamp Duty Land Tax and Stamp Duty) in tax planning matters and can assist with all documentation that may be required.
Please see our separate leaflet on income tax and capital gains tax.