Part 1 covered failure to plan; not planning around the family; not enough cash in the estate; gifts with reservation and out-of-date wills and trusts.
The next five important IHT traps and practical points to consider in this issue are:
Losing the family home
A big mistake is not to recognise that the family home, for most people, is their principal fixed asset and store of value. The possibility of losing the home on death to pay IHT is a major concern for many. Even if not sold, it may have to be remortgaged or loans taken against it to pay for IHT. Planning around the house is of major importance, as families still need to live somewhere, even if other assets may be sold to cover death duties.
A liability such as a mortgage reduces IHT, and so can equity release.
If owned as tenants-in-common, your share of the house can be passed to a nil rate band discretionary trust on your death, for the benefit of your children, enabling you to stay in the house until your death. This is a way of utilising an IHT nil rate band, as an alternative to claiming the spouse exemption, if married or in a civil partnership.
Tip – insure for IHT and mortgage debt to protect the home; consider planning such as equity release to reduce IHT; sever a joint tenancy to use the nil rate band.
Believing your investments have protection when you do not
There is a mistaken belief that investments such as ISAs, share portfolios and investment bonds are IHT free. Yet, they can be IHT fully or partly tax free, if properly ‘tax wrapped’ – and achieve the same income or growth objectives.
Had you ‘wrapped’ an investment bond for IHT mitigation purposes and made it into a ‘discounted gift trust’ (DGT), immediately a percentage is out of your taxable estate and the balance (and growth on it) is out of your estate after a period of seven years.
Diversify a share portfolio into a qualifying EIS portfolio (that may include AIM stocks) qualifying for ‘business property relief’ and survive for two years - the value of the qualifying shares will be out of your estate for IHT purposes, a saving of 40%.
Invest into woodlands for agricultural and business property reliefs to apply - the investments may be 100% out of your estate. There are income tax, capital gains tax and also special IHT reliefs for growing timber passing on death.
Investing into qualifying businesses for business property and agricultural property reliefs at up to 100% may appeal to some.
Gifting of assets can also save on IHT, as long as you survive for seven years and derive no benefit from the gift made.
Tip – consider ‘tax wrapping’ investment bonds for immediate IHT relief; consider EIS portfolios for business property relief after 2 years from IHT; buy commercial properties into pension funds; gift assets.
Not consulting professional advisers
A big mistake is to think that you will cover all of the IHT mitigation and reduction bases yourself. If you do this you take on all of the risk. By using professional advisers, you pass some of the risk on to them. They will have professional indemnity insurance cover; should you be misadvised or mis-sold anything, you can claim against them. Whilst you may make short-term savings in costs and commissions by not taking advice, the peace of mind from obtaining regulated advice cannot be under-estimated.
Professional advisers specialise in different aspects of financial planning and usually adopt a team approach to ensure that you get best overall coverage and advice on those aspects that concern your financial planning.
Tip - Begin shifting the risk now – get advice.
Not having life policies in trust
If a life policy is not written into trust, on your death, 40% of the policy proceeds could be subject to IHT. Life assurance companies offer trusts at no extra charge, or your solicitor can draw up a trust deed for you. It is possible to put your policies into trust after the event, and this may save you thousands of pounds in the long term.
Policy proceeds do not have to pass through probate and the money is available before probate, if in trust. The beneficiaries of the trust, or the trustees, use the proceeds to pay the estate’s IHT liabilities and other liabilities, and to provide for bequests.
Tip - Check policies to see if written under trust, if not it may cost your estate thousands of pounds in IHT.
Not planning pension funds properly
Pension funds can pass to a spouse and dependants, such as children free of IHT. If the pension fund is paid to your estate on death it could be liable to IHT. If payable to charity, no IHT is chargeable. Pension funds passing to third parties who are not charities, will be taxable in your estate. Pension annuities, after their terms have expired, will cease on death and not fall into your estate, and will therefore not be taxed.
Practical Tip – Consider pension reduction strategies, for example, drawing out maximum allowable income drawdown and gifting the excess, or investing it into other IHT savings areas.
Finally, as always seek suitable professional advice where needed.