Inheritance tax (IHT) is payable at 40% on chargeable assets, after exemptions, at death; IHT is also chargeable during your lifetime (at half the death rate of 20%) on certain asset transfers, for example on gifts to a discretionary trust in excess of the nil rate band. The nil rate band is £325,000 in 2011/12 and a married couple or civil partners can generally transfer their unused nil rate bands at death to the surviving partner.
Five important IHT traps and practical points to consider in this issue are:
1. Failure to Plan
Planning points to consider include: (i) using a nil rate band (NRB) trust to make gifts to third parties in trust, then use the spouse exemption which gives 100% tax relief on first death. This way you get early, up-front additional tax relief. (ii) make use of transferable NRBs if married or civil partners. This can reduce IHT on the second death. (iii) equalise estate assets, by gifting to spouses, to utilise more IHT exemptions. (iv) make use of all IHT exemptions whilst alive - to make substantial savings on death. Tax wrap investments – a ‘discounted gift trust’ investment gets immediate IHT relief and gives you income; use your annual gift exemption of £3,000, and unlimited income gifts if surplus to requirements. If not married, make potentially exempt transfers (PETs) early on to benefit from the 7 year IHT rule. Note there is no such thing as a ‘common law spouse’ so the facility for 100% of assets to pass tax free between spouses does not exist for them, nor are NRBs transferable for them. Is marriage an option?
Tax Tip- plan to use as many allowances as possible whilst alive.
2. Not Planning Around the Family
Those leaving assets to you could make your tax position worse. Plan properly using ‘bypass’ trusts and make gifts to other family members to reduce your estate. (i) Grandparents can pay school fees out of normal expenditure and annual allowances to reduce their estates whilst your after-tax money can reduce your mortgage or reduce income tax through pension contributions. Generation planning is therefore an important aspect.
Alternatively, the grandparents could set up a ‘discounted gift trust’ investment bond and secure an immediate IHT deduction for themselves. The beneficiaries could be their grandchildren, thus bypassing your estate. These strategies could save you thousands.
Your adult children could have taxable estates, and inheriting from you could make their positions worse. Similar strategies could be applied to bypass their estates for the benefits of their children.
Tax Tip- discuss wealth creation and preservation with your family members – if you have this kind of relationship with them. Younger members with IHT insurance will probably find it cheaper.
3. Not Enough Estate Liquidity
An IHT liquidity review will ensure you have enough cash available at death to pay taxes, cover liabilities and make bequests without valuable assets needing to be sold – such as the family home. Assets that must be sold usually are at a ‘fire sale’ value and big losses may be made. Many estates are asset rich but cash poor.
Tax Tip – consider life assurance in trust to provide cash when needed most.
4. Gifts Made With Reservation
If you make a gift and reserve a benefit, the value of the gift made will generally fall back into your estate at full value on your death. It will be as if the gift had not been made. This could happen if you gift your house to your children and continue to live there rent free.
Gifts must not be conditional on you receiving any benefits from the gift; gifts to trusts are another area to consider. Always check to ensure that the GWR (gift with reservation) rules do not apply to you.
5. Out of Date Wills and Trusts
Over 60% of people do not have wills, and of those who do, many are out of date or not effective. Examples are where: (i) say your spouse has died, or you are divorced and you leave assets to ‘your spouse’ (ii) assets bequeathed may no longer exist (iii) previous beneficiaries may have passed on (iv) if there is no will and you die intestate and assets pass in a way that you may not have intended – remote relatives whom you dislike may inherit from you! (v) review trusts in wills as significant changes which occurred in 2006 may affect you.
Do not assume that existing wills and trusts are fit for purpose – review them every 2 years. A will can save you IHT. If you die intestate and assets pass unintentionally to 3rd parties, and not to a spouse, it could be costly as IHT may then be charged at 40%. Finally, always seek suitable professional advice where needed.
By Tony Granger