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Inheritance Tax
On death your estate must be valued for inheritance tax purposes and, if UK domiciled, will include all of your worldwide assets. If the value of your estate exceeds the available nil rate band, inheritance tax will be charged on the excess. There are a number of ways to reduce or cover the inheritance tax charge on your estate although not all will appropriate for you. These include:
Exemptions
Gifts made during your lifetime or on death
You can make outright gifts during your lifetime or on death which are exempt from inheritance tax. These include gifts to a spouse or civil partner, charity, political party or national purpose such as museums, National Trust.
Gifts made during your lifetime
In addition, you can make outright gifts during your lifetime which are exempt from inheritance tax. These include:
· Annual gift exemption of £3,000. Where this amount is not fully used, it may be carried forward for one tax year only
· Small gifts of up to £250 can be made to any number of people in the same tax year
· Gifts in consideration of any one marriage or civil partnership (£5,000 to children, £2,500 to grandchildren or £1,000 to other persons)
· Gifts made as part of normal expenditure out of income. To qualify as normal expenditure out of income the gift must not be made out of capital, it must be regular and must not reduce your standard of living.
Outright Gifts
Outright gifts of any amount can be made and, as long as you do not benefit from the gift in any way, the gift will be completely outside of your estate if you survive for seven years. Taper relief may reduce the amount of inheritance tax payable if you survive for at least three years.
Reliefs
Ownership of certain types of asset qualifies for relief against inheritance tax. For example, ownership of business assets can qualify for business property relief at either 50% or 100% after two years of ownership. Some investment products are structured in such a way as to qualify for business property relief but they tend to be higher risk investments.
Whole of life Insurance
Whole of life insurance can be taken out to provide the beneficiaries of your will with sufficient funds to fully or partly cover the estimated inheritance tax charge due on your estate. Policies should be written in trust to ensure funds are available to pay any tax charge.
Will Trusts
Married or civil partners can protect the nil rate band of the first to die through the use of discretionary trusts in their wills. Despite the introduction of right to the transfer any unused inheritance tax nil rate band to the estate of the surviving spouse or civil partner, in many circumstances a will trust may still be a valuable planning tool.
Gifts into Trust
Gifts into most types of trust now attract an inheritance tax charge at the lifetime rate of 20% if the value of the gift plus any similar gifts in the previous seven years amount to more than the nil rate band. However, gifts into trust below the amount of the nil rate band will not be subject to an immediate tax charge and will be completely outside of your estate if you survive for seven years. The assets held in the trust may be subject to ten yearly periodic charges and exit charges. Gifting into trust rather than making outright gifts means you retain control over the money and who receives it. In addition, product providers have designed a number of products which provide relatively straightforward ways of effecting inheritance tax planning through the use of trusts e.g. Discounted Gift Trusts, Gift & Loan Trusts; into which investment bonds can be placed.
Discounted Gift Trust
A Discounted Gift Trust enables you to:
· Make a gift and retain a right to receive regular withdrawals during your lifetime.
· Receive an immediate discount on the value of your gift for inheritance tax purposes.
· Provide benefits to your nominated beneficiaries.
· Ensure any growth on the underlying investments will be outside your estate.
Normally, for a gift to be outside of your estate for inheritance tax purposes you must give up all rights and access to the gift. However, a Discounted Gift Trust is worded in a way that allows a regular payment to be paid to you during your lifetime. You will however lose access to the capital.
In the event of death within seven years of making the gift, HM Revenue & Customs should allow a reduction, or discount, in the value of the gift for inheritance tax purposes. The amount of the discount is based on the level of payments you take and your age, sex and state of health when the trust is set up. In effect, a capital value is placed on the future ‘income’ stream you will receive and this amount is immediately removed from your estate. To avoid the income building back up in your estate it should ideally be spent, gifted or used to fund whole of life insurance.
HM Revenue & Customs can challenge the amount of the discount particularly if they suspect your health was not good at the time of making the gift. For this reason, it is important that you are medically underwritten at this time.
After seven years the full value of the gift and any growth will be outside of your estate.
At some time on or after your death, the trustees may distribute the remaining assets held in the trust to the beneficiaries. The recommended trust would usually be a discretionary trust and therefore the trustees would have discretion to pay out to a range of beneficiaries shown in the trust deed. You would specify in the trust deed who you would want the trustees to give the assets to and in what proportion. The trustees would be under no obligtion to follow your wishes and you may therefore wish to use a professional trustee service which would largely eliminate this risk.
Prior to receiving payments from the trust, the value of the assets in the Discounted Gift Scheme would not be included in the estates of the beneficiaries.
Discretionary trusts have a maximum life of 80 years.
Gift & Loan Trust
If you wish to retain access to the capital then a Gift & Loan Trust may be more appropriate.
Under a Gift & Loan Trust, you set up a trust with a gift of up to your annual gift allowance (£3,000 or £6,000 joint) and then make an interest free loan to the trustees. You would be trustees and under a discretionary trust would retain the right to decide who eventually benefits. This loan is invested by the trustees in an investment bond with the aim of achieving long-term capital growth.
You can choose to have the loan repaid in installments, starting immediately, or at a later date. Either way, all capital growth on the bond accumulates outside of your estate. Repayments would normally be at a rate of 5% each year for 20 years, using regular withdrawals from the bond. Provided you spend or gift these loan repayments the value of your estate, for IHT purposes, will gradually reduce as the loan is repaid.
The full value of the loan (less any repayments) is repayable on demand and therefore, unlike a discounted gift trust, you would have full access to the capital if your circumstances change. However it is only the growth on the loan that will be outside of your estate (plus the full value of the initial gift) and therefore this strategy takes longer to significantly impact on your inheritance tax liability.
In the event of death before the loan has been fully repaid, only the outstanding amount of the loan will be liable to inheritance tax.
In addition to the above, we can provide you with advice on the more specialist inheritance tax planning products available in the market place.
If you wish to discuss the above further or require information on any of our services, then please contact us.
Any reference to legislation and tax is based on The Financial Planning Partnership's understanding of UK law and HM Revenue & Customs practice. These may be subject to change in the future. Tax rates and reliefs will also change and their value to you will depend on your individual circumstances. No guarantees are given regarding the effectiveness of any of the above strategies.