Plan now to avoid paying inheritance tax later
As the Tories set their sights on IHT, Esther Shaw finds ways to maximise your allowance
Saturday 06 October 2007
The usually un-sexy topic of inheritance tax has barely been out of the news since Shadow Chancellor George Osborne (below) made his headline-grabbing, vote-winning pledge at the Party Conference that a Tory government would take family homes out of IHT by raising the threshold to £1m.
IHT was once a tax on the very wealthy, but in recent years, the rise in house prices has meant that many "normal"homes" have been dragged into the IHT net.
Under current rules, you have to pay 40 per cent tax on any assets you leave behind that are worth more than £300,000.
But with the average UK property now worth £218,479, according to the Department of Communities and Local Government, more and more estates are hurtling towards that threshold – especially once the value of other assets, such as savings, life cover and shares are included.
One of the key issues is that the IHT threshold has not kept pace with house price inflation. Since 1995-6, house prices have increased by 199 per cent, according to the Halifax, more than double the increase in the IHT threshold, up 95 per cent to £300,000 for 2007-08.
If the threshold had increased in line with house price inflation since 1995-6, it would now be at a level of £460,000 – more than 50 per cent above the 2007-8 £300,000 IHT threshold.
By contrast, to date, the Government has committed itself in the Finance Acts 2006 and 2007 to raising the threshold to £312,000 next year, and to just £350,000 for 2010-11.
Halifax estimates there are 2.3 million occupied properties in the UK worth more than £300,000 – equating to about 12 per cent of all owner-occupied properties; at the same time it estimates that nearly a third of detached properties are now valued above this threshold.
In 2001, only 1.3 million properties – or 7 per cent of owner-occupied properties – were valued above the then IHT threshold of £242,000.
Critics agree that IHT is a growing problem for many families.
"IHT is one of the most unfair taxes because you are taxed on wealth you have already been taxed on once," says Mel Bien from broker Savills Private Finance. "It doesn't help that the nil-rate band threshold is so low. Given the pace that house prices have risen in recent years, IHT is proving very profitable for the Government."
IHT tax receipts for the last financial year stand at an estimated £3.6bn, according to the Halifax, and are projected to rise to £4bn this year.
As there are currently very few estates that amount to more than £1m, Tory plans to essentially triple the current threshold will make a huge difference.
"It will take millions of estates out of IHT because the threshold for a married couple will effectively be £2m,""says Nicholas Hughes from tax adviser Chiltern.
While these proposed changes depend on the Tories coming into power, the good news is, with good financial advice and careful planning, you can act now to cut the amount that goes to the taxman.
It's relatively simple for people to take advantage of a range of tax exemptions and products to make sure the maximum amount of wealth is passed on to the next generation.
That said, new findings from Bradford & Bingley (B&B) show that nearly two thirds of people have failed to take any advice on how they can minimise the amount they have to pay – while few have even made a will.
"Planning for death may not be top of your to-do list," says B& B spokesman Andrew Stead. "But by seeking advice about how to mitigate against IHT and planning your finances in a tax-efficient way, you can protect your hard-earned assets and protect your families from the burden of financial uncertainty in the future."
It pays to start thinking about how you are going to mitigate your IHT liability as soon as possible.
First, note there is no tax to pay on any amounts passed between married couples and those in civil partnerships, but if you simply give everything to the survivor, your IHT is wasted, as you simply add to their estate, which means they only have one allowance to use whenthey die.
As each individual has a tax-free allowance of £300,000, couples should divide their assets to take full advantage of it.
Some of the simplest ways to reduce IHT involve simple estate planning, including nil-rate band planning using an up-to-date will, and maximising exemptions and pension contributions.
However, many people will not be able to give away their estate because they need the income it generates. "Many people will be faced with the classic IHT dilemma: they have an estate worth more than the nil-rate band, but can't make a gift of capital as they rely on it and the income it generates," says Nick Williams, chartered tax adviser at Clerical Medical, part of the HBOS group along with the Halifax. "The options then for mitigating the anticipated IHT liability include a loan trust, discounted gift and income trust, taking out a life insurance policy, or investing in IHT-efficient investments."
USING AN UP-TO-DATE WILL AND NIL-RATE BAND PLANNING
One of the first key steps in estate planning is drawing up a will.
"While it won't save IHT by itself, it will ensure assets go where they are intended to," says Leonie Kerswill, tax partner at accountant PricewaterhouseCoopers. "Dying without a will may mean assets are passed in accordance with law, and not your intentions. This means tax-saving opportunities – such as the deceased's £300,000 IHT-free allowance – may be lost."
This is particularly important if you are and you partner are not married, as your partner may not be entitled to anything unless your will provides for them.
Consider how the property is owned so both of you utilise your nil-rate band where possible, says Bien.
"One option is to own the property as tenants-in-common: on death, the first spouse can pass their share of the property on to someone other than the surviving spouse, such as a child, thereby using the deceased's nil-rate band.
Then, once the surviving spouse dies, they can leave their share, utilising their own nil-rate band."
A discretionary trust can be used to prevent the value of one partner's estate falling into the estate of the surviving partner, adds Williams.
"Such planning could provide a potential IHT saving of £120,000 – based on the 2007-08 nil rate band of £300,000."
If you own a home overseas, ensure you take local tax advice.
You can reduce the value of an estate for IHT purposes by using the annual IHT exemption which allows you to give away £3,000 a year without incurring a liability to IHT.
"This exemption may be carried forward for one year, but will be lost if not used," says Williams.
You can also use your small gifts exemption and give gifts of up to £250 to any number of people in each tax year.
"If you want to gift a larger amount, then provided you survive seven years from the time of the gift, there will be no IHT to pay," says Kerswill.
This is known as potentially exempt transfers (Pets). "Even if you don't survive the full seven years, after three years the amount of IHT due begins to fall," she adds.
That said, you need to be aware of capital gains tax if you give away assets, warns Anita Monteith from the Institute of Chartered Accountants in England and Wales.
"Check with your accountant first," she says, "and make sure you don't give away money that you might need yourself one day."
You can make gifts on marriage or civil partnership; the amount depends on how the person making the gift is related to the bride, groom or civil partner.
Parents can give £5,000 to a child who is getting married, while grandparents can make a wedding gift of up to £2,500 free of IHT. Anyone else can give £1,000.
Exempt gifts can also be made regularly out of surplus income, provided they do not detract from the standard of living of the person making the gift.
Further, almost all donations to charity are considered exempt and can help to reduce your IHT liability.
A highly tax-efficient way of reducing the value of an estate is by making contributions to a pension which will provide you with income in your retirement years.
One solution for people who want flexible access to capital is a loan trust, where you lend funds to a trust created for family or friends to benefit from.
"These funds are invested to provide an income or capital growth but you can access the loaned funds at any time," says Williams.
Any income or growth arising on the investment is immediately outside your estate for IHT purposes.
DISCOUNTED GIFT AND INCOME TRUST
A discounted gift and income trust might be suitable for people who require only a fixed income each year, according to Williams.
"You make a gift of funds to a trust you have created for family or friends to benefit from and retain a right to income," he says. " Income is paid until you die or the fund has been exhausted. The value of the gift made to the trustees may also be discounted for IHT purposes, depending on your life expectancy and the amount of income you choose to receive.""
Look at your life insurance arrangements, and if you have a policy, make sure it is "written in trust" for beneficiaries, such as your children, says Monteith.
"If not, it will be treated as part of your taxable estate."
You should also consider insuring yourself to meet the IHT liability, adds Kerswill.
INVEST IN ASSETS
You can invest in assets that qualify for an IHT relief, such as business property relief or agricultural property relief, says Williams.
"Assets such as shares in unquoted trading companies – including AIM stocks – would provide a tax-efficient, but high-risk, investment.
DEED OF VARIATION
If your partner dies without amending their will to enable tax planning to avoid IHT, the beneficiary has the opportunity to enter into a Deed of Variation – to alter their will to set up a trust or to redistribute assets more tax-efficiently. But you only have two years from their death to do this.
'I've paid tax all my life. Why must I pay when I die?'
Roger and Rosemary Jenkins, both 64, from Walton-on-Thames, Surrey are keen to leave as much money as they can to their family, and are now taking steps to cut their inheritance tax bill.
The couple, who have two sons, aged 29 and 32, own a semi-detached house in Surrey, and have seen the value of their home rocket in the time they lived there.
As they also have other savings – including an investment portfolio of individual saving accounts (ISAs) – planning to avoid IHT is essential.
Roger and Rosemary were concerned that they had done no planning and decided to seek advice from first a solicitor, and then a financial adviser, to find out if they could cut the amount of money that goes to the taxman.
"We became aware of the issue of IHT, and with two children, we wanted to do all we could to avoid the money going into the Chancellor's coffers, and to help the family instead," says Roger, a retired stockbroker who now works part-time in a garden centre.
After taking advice from the financial adviser, they opted to take out a discounted gift and income bond through Clerical Medical.
This type of IHT planning scheme has become very popular, and HMRC has paid attention to these schemes recently, taking action to produce greater clarity.
"The discounted gift and income bond sounded like a good solution," says Roger. "It has got a risk factor, but gives a stable income."
He feels very aggrieved about having to pay IHT.
"I knew there was a problem with IHT because of house prices and the fact they have shot up," he says. "A lot more people are caught in the net now – and yet it's something over which you have no control."
Roger says that as he and Rosemary have to face the fact they are not going to live forever, it was important to find ways to mitigate their IHT liability.
"I have worked for 40 years and paid tax all my working life, so why should I pay it when I die?" he says. "I want to be able to leave as much money as possible to my family."
Roger is happy that he has started making provision to cut his bill, but adds that the plans will need to be reviewed again in the near future.
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