Inheritance Tax Planning
Setting up a will should be the first step in any estate-planning exercise, not only to make certain that matters are dealt with in a tax-efficient way but to ensure that your wishes are carried out. Having a will means you avoid relying on the intestacy rules that come into play where there is no will. Effectively the law decides what happens to the estate, which can lead to financial anxiety for the surviving spouse along with a possible immediate charge to inheritance tax (IHT) on the first death.
It is also important to consider wills for those who aren’t married with children, but who have considerable assets, since under the rules of intestacy the estate would pass to their parents (rather than brothers or sisters), potentially exacerbating their IHT liability.
Check that you actually have an IHT liability
It may sound obvious, but it is worth considering when IHT actually applies.
Each individual has a tax-free allowance of £325,000, known as the nil-rate band. IHT only applies to the value of the estate above this at a rate of 40 per cent on death.
However, transfers between husband and wife are exempt from IHT. If the nil-rate band is not used on the first death, the value of the estate on the second death that will be exempt from IHT doubles to £650,000.
Take advantage of exemptions
You can give away up to £3,000 a year, which is known as your annual allowance, and this will be immediately exempt from IHT.
There is also a small gift exemption, meaning you can give up to £250 to as many people as you like.
Wedding gifts up to £5,000 for parents, £2,500 for grandparents and £1,000 for everyone else are eligible as well, as are donations to qualifying charities.
Gifts of cash or assets worth more than the annual allowance will also be exempt as long as you survive for seven years from the date of the gift. These are known as potentially exempt transfers.
Make gifts out of excess income
You can make ‘gifts out of income’ free from IHT.
For the gifts to qualify, they must form part of normal expenditure, be made out of income and they cannot reduce your standard of living.
This exemption is claimed by the executors of your estate, so it is important to keep good records both of gifts made and of your normal expenditure.
Identify assets that can be given away free of Capital Gains Tax
Should you hold assets that have fallen in value since purchase (property, quoted shares, etc) then they could be gifted without attracting capital gains tax (CGT).
This would crystallise a capital loss which can be carried forward to offset against future gains. Any recovery in the value of the gifted asset would then accrue in the estate of the recipient, and the gift would be a potentially exempt transfer and so outside of the estate after seven years.
Take out life cover
One of the simplest ways of providing funds to pay the inheritance tax liability is to establish a whole-of-life insurance policy.
This is designed to pay a sum equal to the tax liability into trust where the money is exempt from IHT and will be available for beneficiaries to pay the tax due.
The payment of the death benefit will happen immediately following death and the funds will be available to pay the tax without any need to wait for grant of probate.
It is possible to gift an amount up to the nil-rate band of £325,000 per individual into discretionary trust (double this amount for a married couple) and this can then be repeated every seven years.
More can be gifted into a discretionary trust but anything above the allowance would incur a lifetime transfer tax of 20%.
Trusts can also allow CGT rollover, continuing control over the assets, ring fencing and protection from beneficiaries or those claiming through them, such as former spouses or creditors.
Preserve access to income
In general the ‘gift with reservation of benefit’ rules prevent an asset being given away during a person’s lifetime whilst allowing continued use or enjoyment of that asset. Any such gifts would simply be treated as part of the donor’s estate for IHT purposes.
This would apply, for instance, to a holiday home in the parents’ names that is given to the children either in whole or in part and which the parents visit frequently.
However, it is possible to preserve access to income while gifting the right to capital by taking advantage of specially designed discounted gift trusts. These trusts will provide an immediate IHT saving on the gift into trust, with the remaining capital being exempt after seven years while retaining a right to income.
Look into business property relief
It is possible to invest in certain discretionary management services that provide investment into unquoted companies. These are exempt from IHT after two years.
This requires careful advice and planning due to the higher risks involved with this kind of investment.
The first step for those with a business (sole traders, partnership or an unquoted trading company) should be to find out if they qualify for 100 per cent relief under the business property relief rules. Has the business interest been held for two years? Are the majority of the assets in the business used for trading purposes? Is the business a trade or an investment?
Consider making gifts to charity
Gifts to Charity are exempt from IHT, but if you give 10% of your net estate (the total estate value less the £325,000 nil-rate band) then the rate of IHT that applies to the remaining estate falls to 36 per cent.
Many people make gifts to charity in their will so it is worth taking this allowance into consideration.