How to leave your assets to your heirs, not the taxman
More families are being caught out by inheritance tax. David Prosser has tips on avoiding it
Saturday 24 March 2007
Ineritance tax (IHT) may have escaped Gordon Brown's reforming zeal, but that doesn't mean you can afford to forget about it. Reform of the tax has been rumoured before each of the chancellor's 11 budgets, but though it has largely been ignored by Brown, IHT has become a real headache for millions of families.
The number of estates caught up in the tax each year remains relatively low, but much of middle England is now affected, because house price inflation has taken them into the IHT net. Halifax Bank reckons the Treasury will have made £16.4bn from IHT over the five years to the end of the 2007/08 tax year, twice the take in the previous five years. But there are ways to beat it.
Everyone is allowed to leave a certain amount of assets to their heirs tax-free. This year, IHT is only payable on estates worth more than £285,000 and the threshold - accountants call it the nil-rate band - rises to £300,000 on 5 April, when the 2007-08 tax year begins (the chancellor promised this week to raise the band to £350,000 by 2010).
Almost everything you own, including the value of your home, counts towards the total, and IHT is payable at 40 per cent on the value of your estate above the threshold. However, any debts you still have on death will come off the total, as will the value of any gifts you bequeath to charity.
One further exemption is that a business you have owned for more than two years does not count towards the value of your estate. Shares listed on the Alternative Investment Market count as business assets for this purpose.
GIVING IT AWAY
If you're already over the threshold, making gifts during your lifetime is one way to bring down the value of your estate. However, there are some strict rules about the gifts you can make. The most basic of these is that you can't make gifts of more than £250 that total more than £3,000 each tax year. If you don't use this allowance one year, you can carry it forward to the next.
Gifts of less than £250, however, are fine. You can make as many of these as you like each year, but each one must be to a different person and you can't give to people who are benefiting from a larger gift. The only exception is that parents can give a child up to £5,000 on their marriage - grandparents can give up to £1,500.
You can also make regular gifts of any size out of your income, as long as you can show your standard of living is not being reduced.
POTENTIALLY EXEMPT TRANSFERS
Gifts you make that aren't covered by the exemptions will only fall outside of your estate for IHT purposes if you live for seven years after making them. Such gifts are known as potentially exempt transfers (PETs). You can make as many of these gifts as you want - and of any value. As long as you live for seven years after making them, they won't count when the final value of your estate is totted up.
Married couples are entitled to a nil-rate band each, but many don't use this perk - and their heirs pay too much tax as a result.
Let's assume that the husband dies before the wife. Spouses never have to pay tax on estates bequeathed by their partners, so the husband can leave all his assets to his wife without worrying about IHT. Doing so, however, means his nil-rate band is unused.
It would be better if each partner left assets worth up to the IHT threshold to someone else - probably children. That way, the value of the estate left to the wife is smaller and the tax bill for her heirs would be lower. However, for this to be practical, couples ideally need to have liquid assets.
TURN CAPITAL INTO INCOME
One problem faced by many families is that they have large sums tied up in capital - either large investments, or property - but little income from which to make gifts that will reduce the size of their estates for IHT purposes. But there are ways round this issue.
One option is to use savings to buy an annuity from an insurance company. Such products pay out a lifetime income at a guaranteed rate in return for your capital. You can then use this money as you wish.
Alternatively, equity release products allow you to unlock capital tied up in your home. You effectively sell part of the property in return for a lump sum or regular income. This has the effect of reducing the size of your estate.
PLAN FOR THE COST
If you can't beat IHT, you can help your heirs meet the cost of the tax bill by taking out life insurance. Despite reforms to the laws on trusts last year, you are still entitled to set up such policies within a trust - the proceeds won't then fall within the value of your estate.
Equity release products can give you access to money you had thought tied up. Keep enough to live on in old age, but don't feel selfish about spending the rest.
The easiest ways to cut IHT
* Make a will, with advice from a solicitor. This is the best way to ensure your family receives what you expect in the most tax-efficient fashion possible.
* If you are married, consider transfers of assets between you, which are free of tax. Each spouse has their own allowance - make sure you use both.
* Consider making gifts to your children or grandchildren, who will be entitled to the assets free of IHT as long as you survive for seven years after making the gift.
* Business assets are free from IHT as long as you have owned them for two years. Shares on the Alternative Investment Market count as business assets.
* Remember that all gifts to charity - plus gifts to political parties - are free from IHT however long you live after making them.
* Never make investment decisions purely to get a tax saving. And be very cautious about expensive tax-planning schemes promoted by financial advisers and accountants.
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