Make your money work - beyond the grave

You can still avoid inheritance tax, but many believe the Government will tighten the Revenue's net. Now is the time to act
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The Independent Online

It used to be known colloquially by the far from consumer-friendly phrase "death duties". Introduced more than a century ago as estate duty, to raise revenue from wealthy families, its modern-day descendant - inheritance tyax (IHT) - casts a far wider net.

It used to be known colloquially by the far from consumer-friendly phrase "death duties". Introduced more than a century ago as estate duty, to raise revenue from wealthy families, its modern-day descendant - inheritance tyax (IHT) - casts a far wider net.

But there are exemptions for business or agricultural property and, most importantly, for assets passing between husband and wife.

IHT is levied at 40 per cent on the value of estates above £231,000. This may appear to be a high figure but, given the boom in property values since the 1970s, many homes are worth more than this.

Add an increasing prosperity, wider share ownership and the fact that the 50-plus age group is inheriting sizeable sums from elderly relatives, and it means more estates will be paying IHT. The Revenue should collect £2bn in IHT this tax year.

Before coming into power, the Labour Party said: "It is unacceptable that IHT can be operated by tax planners as a 'voluntary tax'."

Although many financial planners expected the Labour Government to make it more difficult to avoid IHT, nothing has happened yet. Financial advisers such as the David Aaron Partnership say this doesn't mean it won't act.

The Aaron Partnership considers the rates of tax could rise, and some of the tax planning strategies which reduce or eliminate the payment of the tax could be abolished. The run-up to the 21 March Budget is an ideal time to take action.

So, what should you do? It may sound obvious, but first estimate the likely size of your estate. Apart from your home, investments and valuables, do not forget life cover. For married couples this should be a joint project. If the joint total exceeds the threshold, see a financial adviser.

Aaron advises that IHT planning can be achieved in four main ways:

Making gifts of assets during your lifetime;

Careful drafting of wills;

Using trusts, and

Making provisions for the payment of tax by your beneficiaries.

Simply transferring the deeds of your home into the name of your heirs will not satisfy the first point if you retain a formal right to live there without payment. The home continues to form part of your estate unless the full market rent is paid.

Complex schemes do exist for very valuable property where there is a desire for it to remain in the family. But the Revenue scrutinises the circumstances of each case and will dismiss situations it regards as provocative.

A gift is considered a disposal by way of sale at full market value. So a capital gains tax (CGT) liability may arise if the donor exceeds the personal allowance of £7,100 and the gift was not exempt from CGT. Exempt CGT assets include cash, gilts and the donor's principal residence. Gifts will not necessarily escape IHT. Those that do are regular transfers out of income that do not affect the donor's standard of living.

Individuals may transfer up to £3,000 out of capital. If this exemption is unused in one year, it may be carried forward to the next, providing the full exemption is then used. Each person may also make small annual gifts of up to £250 for separate individuals.

Other gifts to an individual and certain types of trust are called a potentially exempt transfer (PET). This means no tax is paid at the time, but a liability arises in the event of the donor dying within seven years. The IHT payable decreases the longer the donor survives. This is known as tapering relief.

During the first three years there is no exemption, but if death occurs in the fourth year, the relief is 20 per cent. This increases annually by 20 per cent to 80 per cent in the seventh year, and to 100 per cent if the donor survives more than seven years after the gift is made. Should IHT become payable, it is assessed on the value at the time the gift is made.

For the majority of people, making significant gifts during their lifetimes is not practical. It is not only essential for everyone to make a will to ensure that their assets devolve as they wish, but significant IHT savings can also be achieved. Wills should be regularly updated to reflect changing circumstances.

Instead of a husband and wife leaving all their assets under the will to the survivor on the first death, consideration should be given to leaving assets up to the IHT nil rate band to children, with the balance going to the survivor. The result is that both parties are using their £231,000 IHT threshold and £92,400 in IHT will be saved on the second death.

As leaving assets to children on the first death could affect the standard of living and financial security of the surviving spouse, many couples are reluctant to make an outright bequest.

A solution is to transfer the assets to a discretionary trust. This is an extremely flexible arrangement as the trustees not only have complete discretion as to the beneficiaries, but can also distribute capital as well as income.

There is another method: a life policy held in trust for the main beneficiaries who will have to bear the burden of IHT. As the policy is held in trust, it will not form part of the estate. A husband and wife aged 60 who are in good health could secure a sum of £300,000 a year on the second death with an annual premium of £3,000. This sum is an individual's annual gift exemption.

As Brendan Francis once remarked about money: "True, you can't take it with you but, then, that's not the place where it comes in handy." When you are no longer here, your money could be better used by your family as opposed to the government, so take action.

You should enter arrangements to reduce the burden of IHT only if you feel comfortable with the situation. There is no point in enhancing the lifestyle of your heirs if yours suffers. Unfortunately, none of us knows our own needs in old age.

The David Aaron Partnership publishes an excellent booklet, 'Inheritance Tax - Plan Today to Save Tax Tomorrow'. It is available, price £2, from: David Aaron Partnership, Shelton House, High Street, Woburn Sands, Milton Keynes, MK17 8SD

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