Chancellor's freeze will pull more into inheritance tax net
With the threshold fixed until 2019, many more ordinary families will need to consider estate planning. Esther Shaw looks at the issues
Sunday 17 February 2013
Families are being urged to carry out some careful inheritance tax planning after the Government announced that it was freezing the threshold at the current £325,000 until at least 2019 to fund reform of the social care system.
The IHT threshold had been set to stay at its current level until 2015-16, before rising to £329,000, to help fund care home costs.
The extension means the Chancellor, George Osborne, has reneged on a promise, made during his time in opposition, to raise the threshold to £1m.
"The Chancellor's decision to freeze the IHT threshold will not be a popular one," says Karen Barrett at the Unbiased.co.uk advice website. "Taxpayers work hard to ensure they leave assets to benefit the loved ones they leave behind, not leave them with a tax liability."
While the freeze will help fund a £75,000 cap on the cost of care, enabling some families to keep their homes, more people will be dragged into the IHT net; figures suggest a further 5,000 people could be paying IHT.
"The Coalition's U-turn on its flagship pledge to reform the IHT system is expected to affect thousands of middle-class Britons," says Kevin White at the adviser deVere United Kingdom.
Claire Walsh at Pavilion Financial Services adds that rising house prices – particularly in the south-east – coupled with the IHT freeze will hit families hard. "Increasing numbers of relatively ordinary families will find themselves facing IHT bills," she warns.
As many more people could now potentially face a sizeable bill, the key is to take steps to limit the amount taken from your estate.
Figures from Unbiased show that UK taxpayers wasted as much as £448m in poor IHT planning last year – and that was just when it came to placing life insurance policies in trust – demonstrating how important it is to plan ahead.
The good news is that there are a range of measures you can take to reduce potential IHT bills and, with the end of the tax year fast approaching, now is the time to re-evaluate your IHT efficiency.
Danny Cox at Hargreaves Lansdown says there are two basic methods of reducing IHT.
"The first involves reducing the size of the taxable estate and the second involves providing additional funds to meet the tax."
Here we take a look at some of the options.
One of the simplest ways to reduce the size of the taxable estate is by making gifts from excess income.
Mr Cox says: "This normally means giving money away, either by lump sums or regular amounts. You can gift as much surplus income as you like without IHT consequences."
Each individual also has an annual exception which permits gifts of capital of up to £3,000 to a person or people of your choice.
Ms Walsh says: "This can be carried forward to the next tax year, permitting up to £6,000 to be gifted at once." "An unlimited number of small gifts of up to £250 are also permitted, provided no more than £250 is given to any one person; larger gifts on marriage are also allowed." (See box left.)
Crucially, gifts must be made at least seven years before death to avoid IHT in full.
If you are unable to gift assets, there is the option of taking out an insurance policy to cover some or all of a future liability.
"Life insurance can be a good solution to an IHT problem," Mr Cox says. "If you take out a life insurance plan so that on your death the value of the policy is paid to your beneficiaries, they can use the proceeds to meet the tax, thereby preserving your estate. The premiums aren't as expensive as you might think, since most policies for IHT planning are set up on a 'joint life second death' basis."
The policy is then written into trust so that the death benefit is completely tax free.
David Smith at adviser BestInvest says: "The proceeds of a 'whole of life policy' written under trust will bypass the Estate and pass straight to the beneficiaries. While this does not limit the amount of IHT payable, the beneficiaries can use this to assist with the payment of the IHT liability."
If you want to make a gift for tax-planning purposes but don't want the beneficiaries to collect their gift yet, you could use a trust.
"This can delay the distribution of money or assets until such a time as is appropriate," Mr Cox says.
This might be the case if, say, the beneficiary is under 18. "But if you're considering establishing trusts for grandchildren, you must note that these become fully exempt from IHT only if you live for a further seven years," Mr Smith notes.
Discounted gift plans
These plans are suited to those who are willing to give up access to their capital but who need to receive regular distributions from this money.
"A lump sum is invested and a proportion of this, typically, immediately falls outside of the estate for IHT purposes," Mr Smith says. "The exact amount is dependent on the age and health, and is calculated in line with HMRC guidelines."
The remainder falls outside of the estate after seven years.
"The benefit of this plan is that it will provide monthly payments to the individuals for as long as the investment has sufficient value to fund them," he says. "With good planning, this should be for life."
EIS schemes and AIM portfolios
Another way you can avoid paying excess IHT is by investing in portfolios of Enterprise Investment Schemes (EIS) or qualifying Alternative Investment Market shares.
After a period of two years, the value of any EIS investment will be outside that person's estate for IHT, according to John Williams of the EIS investment platform Kuber Ventures. "Therefore after death, beneficiaries will receive 100 per cent of the return."
This is known as Business Property Relief (BPF), and was introduced by the Government to incentivise investment in a trading business.
For the same reason, AIM shares are also exempt from an estate provided they have been held for two years or more at the time of death.
"But both these investments carry high levels of risk and require liquid assets to make the investment," Mr Smith warns. "So while useful for some wealthy investors, they will have limited appeal for those whose wealth is principally tied up in their homes."
A new IHT tool has just been launched to financial advisers, using BPF with a minimum target annual return of 3.5 per cent.
Under Time:Advance, clients buy shares in UK businesses that invest in ungeared asset-backed trading businesses, such as lending secured on property. Once again, investments will become fully exempt from IHT after two years.
"This scheme invests in unquoted shares, which is higher risk than investing in, say, FTSE 100 blue chips," Mr Cox says. "The share prices will be more volatile and the stock less liquid, meaning they are harder to sell. On the plus side, the investment will be diverse and a professional manager makes the decisions on which shares to buy and sell – checking they qualify for BPF. But these are specialist investment schemes, and investors should choose providers with good track records running these types of portfolio."
If in doubt about any type of IHT planning, the key is to take independent financial advice.
When it comes to reducing IHT liability, certain tactics are not permitted. It is not permissible, for example, to gift an asset and continue to enjoy its benefit.
"You cannot gift your property to your children and carry on living there, as this is classed as a Gift with Reservation," Ms Walsh says. "Unless you are paying rent, full IHT will be liable on your death."
Equally, any gifts, whether directly or into trusts, must be made at least seven years before death in order to avoid IHT in full.
Mr Smith also points out that you cannot sell an asset at a discount to try to reduce IHT, as the actual market value will be used to calculate the value of the estate.
IHT rules made simple
Up to £325,000 of an individual's estate will potentially be exempt from IHT and any unused allowances can be passed to a surviving spouse, giving a total potential allowance of £650,000. Transfers between UK-domiciled spouses are exempt from IHT.
Any excess above the available "nil rate bands" will be subject to IHT at 40 per cent.
A reduced rate of 36 per cent will be applied if you leave at least 10 per cent of assets to charity.
YOU can gift up to £3,000 in each tax year for IHT purposes; any unused gift allowance can be carried forward to the following year.
Gifts of up to £250 to any number of people are exempt from IHT, but no one person can get more than £250.
Making regular gifts out of normal expenditure is a useful way to reduce IHT.
Parents and grandparents can make one-off gifts on the marriage of children or grandchildren, up to £5,000 and £2,500, respectively.
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