A logical approach to inheritance tax planning
Protecting what is rightfully yours
The first place to start is to consider where you want your money to go and why. Many people have reservations about giving away assets too quickly, they trust their children, but not always their children’s marriage partners.
A basic calculation will give you an indication about whether or not you have a potential liability to inheritance tax (IHT) in the event of your premature death. This can be done by adding up the value of your savings, investments, property and personal possessions. Do not forget personal equity plans (PEPs) and individual savings accounts (ISAs), though they are tax−free during your lifetime they form part of your estate for IHT. Finally, take off the value of any debts. If the total adds up to more than £600,000 for a married couple or registered civil partnership, or £300,000 for an individual then IHT will apply.
It is essential that you make a Will which makes your wishes concrete and clarifies who should get what. It will also stop any assets being divided under the rules of intestacy, where even spouses are not guaranteed to inherit everything. It can also be the first step to reducing an inheritance tax bill.
Many married couples draft Wills that pay part of their wealth into a trust on death. The surviving spouse can benefit from the legacy, but so can others such as children and grandchildren. The aim is to give the option for both husband and wife to use their full IHT allowance on death.
Don’t forget that you cannot be taxed on money that was never yours. So ensure that as much as possible is outside your estate. Write any new life insurance plans under an appropriate trust. Many existing life policies can be transferred into an appropriate trust. If your employer pays a death benefit, complete a nomination form to make sure any money goes directly to the person you choose and not into your estate.
It is also worth thinking about legacies you receive. Someone who benefits from a legacy can divert that gift to another person. You can apply for a ’deed of variation’ within two years of the death of the giver. Also remember that anything you pass on to a spouse is free of inheritance tax. The same concession applies to same−sex couples who register under civil partnership laws.
However, legacies between unmarried couples are not tax free, which is problem when a couple jointly own their home. This can lead to people having to pay an IHT bill just to continue living in their home.
For many families, their home is typically their biggest asset and potentially their biggest inheritance tax problem. The Government has clamped down on schemes to get around the ’gifts with reservation’ rules. These allowed people to give away homes, but still live in them. Now, income tax can be charged for living rent−free in a home you once owned. But there are still ways to reduce IHT. Most couples who own a home together are joint tenants. This means that if one person dies, the other automatically becomes the outright owner of the property.
The alternative is to register as ’tenants in common’, each owning half the property absolutely. This means that on death, your share may be left to someone else to keep down the size of your estate.
Some investments also receive favourable treatment for IHT purposes, including shares in unquoted businesses, woodlands, farms and farmland. Many shares on the Alternative Investment Market (AIM) stockmarket also qualify for relief.
There are several trusts, aside from Will trusts, that could also assist in estate planning. Depending on the type you choose, it can still be possible to enjoy an income from money paid into trust, even though you are no longer the legal owner of that money. Professional advice is essential for anyone considering setting up trusts.
Another option is to estimate how big a potential IHT bill that your heirs could face would be and arrange insurance to cover part or all of it. Whole−of−life insurance written under trust can provide a lump sum on death that is outside an estate.
On death, the proceeds of the policy can be used to settle the tax bill. The premiums are treated for tax purposes as a gift from regular income. Think of this as building a fund to pay your tax. The advantage is that you retain your wealth through your lifetime and so have the funds if, for example, you need to go into long−term care.
There is also the option to give away money that would reduce your estates value, but will not cut the tax liability immediately. You have to survive for seven years for most gifts to escape the IHT net. However, within that last seven years, HM Revenue & Customs (HMRC) allow gifts of up to £3,000 each tax year. Unlimited gifts up to £250 a person per tax year are exempt, as are payments up to £5,000 for wedding gifts.
The most powerful concession is that regular gifts made from normal income can be exempt from IHT. You must show you have been giving regularly and are not materially reducing your standard of living or running down savings. This concession allows parents or grandparents to help children without fear of inheritance tax problems down the line.
However, HMRC will demand details of these gifts when the giver dies.
Levels and bases of, and reliefs from, taxation are subject to change.
