Avoid Inheritance Tax

Inheritance Tax (IHT) has been described as a voluntary and avoidable tax by successive Governments.

Yet if it is so voluntary and avoidable, why is the Government anticipated to collect £4.1 billion in 2007-08? This is the figure suggested by HM Revenue & Customs statistics.

Clearly, to many families, it is not as voluntary or avoidable as they may have thought!

Inheritance Tax The Avoidable Tax

But is it only a problem for the rich? It all depends on how one defines rich. There are many of us who will suffer IHT, yet do not feel particularly wealthy. One of the reasons for this wealth is the value of our homes, which for most people represents the largest single asset we own.

Calculating Your Inheritance Tax Liability

Depending on the nature of the assets within your estate, calculating the tax is fairly straightforward broadly, add up the value of all your assets, including your home, deduct the nil rate band £300,000 (2007-2008) and tax the remainder at 40%.

You may however be entitled to your deceased spouse's nil rate band if it was unused in whole or in part.

Basically, everything you own is potentially taxable, your home, your investments, your cash in the bank or building society, your cars, any second homes (wherever they are in the world), your furniture, antiques, jewellery etc.

For example, if you are worth £1 million, taking away £300,000 leaves £700,000 so tax at 40% will be £280,000, leaving £720,000 for distribution amongst your family.

Nearly 30% has gone to the Government.

So, if you have three individuals whom you would like to benefit equally, they will each receive £240,000.

The largest single recipient is the Government!

A Painful Legacy

While calculating the tax may be straightforward, paying it may not.

Other than in exceptional circumstances, the Government want to be paid in cash, not goods or assets.

For most people, their assets are a combination of investments together with their home. It is rare to meet someone who has one third of their wealth in cash.

So, for most people something will need to be sold, perhaps the asset you most wanted to pass on to your children.

And the liability needs to be paid to the Government before the remainder of the estate can pass to your heirs, creating a headache for them at what is almost certainly a difficult and traumatic time.

If you would prefer to pass on as much of your wealth to your family as you can, please read on.

How Can I Avoid IHT?

There are some fundamental aspects to reducing the impact of the tax.

Use Your Exemptions

You are allowed to make various gifts, some quite small, that are ignored completely for tax purposes. These are known as exempt gifts.

The Revenue allows 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, HM Revenue & Customs will demand details of these gifts when the giver dies.

Make Larger Gifts

Once you have used up your exemptions, you can make larger gifts which will only be taxable if you die within seven years of making the gift.

Potentially Exempt Transfers (PETs) are still available after the Finance Act 2006 where you make an outright gift, including a gift into bare trust or a gift into a disabled trust. There are various ways and means of making gifts whilst retaining access to your capital.

Make Use Of The Exemption For Transfers Between Husband And Wife Or Registered Civil Partners

All gifts between spouses or civil partners are exempt, whether they are made in your lifetime or on death. It can make sense to ensure that both of you have sufficient funds to each make annual and other lifetime gifts.

Make Gifts In A Safe And Secure Way

You can make gifts through trusts which will make sure that the gifts are protected, e.g. in the event of a divorce of the recipient or banks calling in debts owed by the person to whom you are making the gift.

In addition, trusts can be used to ensure that the assets are made available to your chosen beneficiaries when you want, within certain limits.

These types of trusts are called Discretionary Trusts.

Make Sure You Have IHT Efficient Wills

While those who are either married or in civil partnership don’ t always need to make full use of both nil rate bands on first death as now the amount that can be transferred on death without triggering an IHT liability, an efficient Will can still reduce your IHT bill.

Create A Fund That Will Be Used To Pay The Tax

Life assurance can provide a very simple and cost effective solution for many people, especially if they are in good health.

Take Advice Before Taking Action

IHT is very complex and it is easy to get things wrong accidentally, especially if you intend to do your own planning.

Taking one action to reduce IHT can have implications for other taxes, often with no going back; therefore, it is crucial that you take advice before taking action, especially in light of the Finance Act 2006.

For example, it may make financial sense to gift some shares to a son or daughter.

Simply transferring shares across will be a gift for IHT purposes, but it will also be a disposal for Capital Gains Tax (CGT) purposes.

You could end up with a CGT liability nearly as great as the IHT you were hoping to save.

Important Caveat

This article is written for people domiciled in the UK.

If you have an international element to your family, and then this article may not contain advice relevant to you.

In addition, it does not deal with areas such as gifts to charity or any business interests you may have, both of which have special rules that can reduce the amount of IHT payable. Great care needs to be taken so as not to lose these special reliefs.

Finally, no account is taken of any interests in a trust fund you may have. It is designed to give you a very general overview of IHT but is not a substitute for specific individual advice.

What Solutions Are There?

There's a range of solutions that can meet the needs of most people when it comes to IHT.

For example, many people have asked:

Can I make a gift and still receive an income from the gifted assets?

Can I make a large gift that reduces my IHT bill instantly, without having to wait seven years?

Can I mitigate IHT whilst retaining access and control of my assets?

Can I make a gift and then change the recipient later on?

Can I make a gift to my son or daughter that will be protected in the event of them getting divorced?

Can I make a gift of assets that have large capital gains without incurring a CGT charge?

Can my partner and I protect our assets even though we are not married?

Is it still appropriate that we write our Wills so that we both have access to the entire estate yet still make use of two nil rate bands?

Can I protect my pension scheme death benefits from IHT on my spouse s death, assuming I die before him/her?

Can I leave funds to a charity without disinheriting my children?

Can I create a guaranteed legacy for my granddaughter without impacting on what I leave my children?

Can I provide for my IHT bill now, at a cost that won't increase in the future?

The answer to all of these questions is yes but the exact solution will vary from person to person.

The Next Step

If you see IHT as a problem and you want to reduce its impact, the next step is to have an informal conversation with an adviser. They will help you clarify the scale of your need and to recommend a course of action that meets your personal aims and objectives.

Wills, Trusts and some areas of Inheritance Tax Planning are not regulated by the Financial Services Authority.

St. James's Place Wealth Management specialise in advising clients on all aspects of IHT planning, with the aid of their own in-house team of tax professionals and some of the best tax lawyers in practice today.

For further advice you can contact Graham Kerner or visit www.sjpp.co.uk/grahamkerner to receive their free brochures. 

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