Moving on

Estate planning

Inheritance tax (IHT) is an issue affecting increasing numbers of households across the country.

Changes introduced in Chancellor Alistair Darling’s pre-Budget report in October 2007 have made it more straightforward for couples and civil partners to combine their individual IHT allowances, so that it is easier for them to protect their families’ inheritance.

But years of rising property prices mean that thousands of families would be wise to seek estate planning advice, to help them pass on as much of their assets to their loved ones as possible, rather than to the taxman.

IHT facts

• Inheritance tax was introduced in 1986, although a tax on a deceased person’s estate – their home, other property, savings and investments – has existed in the UK since the late 19th century.

• When IHT was introduced in 1986, an estate had to be worth £71,000 to be liable for IHT. In those days, the average price of a house was just £36,000.

• The individual allowance is now £300,000 and the average cost* of a detached house in the UK is £353,096. The individual allowance will rise to £350,000 by 2010. (*As at December 2007)

• The tax is levied at 40 per cent of assets above the allowance threshold on a person’s death.

• It raises more than £3.3 billion a year for the government.

How IHT works
Each individual has a £300,000 allowance before they pay IHT on assets passed to their heirs, not including their spouse or civil partner.

The change introduced in the October 2007 pre-Budget report makes it easier for married couples and civil partners to leave up to £600,000 between them without incurring IHT.

Technically this has always been possible, but many people have failed to take the necessary action because it involved changing the ownership of the home, drafting a new and setting up a trust.

Couples and civil partners who transfer their share of their home and other assets to the surviving partner can now also pass on any unused part of their individual IHT allowance of £300,000. Assuming they have used none of their allowance, on the second death IHT is paid only on assets of more than £600,000.

Any widow or widower – regardless of how long ago their spouse died – will be able to add their partner’s allowance to their own, minus any deductions, such as transfer of money into trusts, or lifetime gifts that date back less than seven years.

When someone dies, their estate is valued to calculate the appropriate IHT to be paid, taking into account the relevant exemptions.

In most cases, IHT must be paid six months after the end of the month of death, which can be challenging timescale: winding up an estate can take a long time, particularly if involves selling a property or a business. Tax on some assets, including land and buildings, can be deferred and paid in installments over 10 years, with interest.

The process can be complex – as are the HM Revenue & Customs documents that need to be completed – and seeking professional expertise is advised.

Exemptions, reliefs and gifts
Various transfers and gifts exempt from inheritance tax should be considered as part of your estate planning.  The following table and information provides a quick guide – this is not comprehensive and professional advice is recommended.

Gifts
The table below summarises gifts exempt from IHT.

Gift	Value
Annual gift	£3,000 (£6,000 if no gift was made the previous year)
Small gifts	£250 (an unlimited number of £250 gifts to different people)
Wedding/civil partnership gifts	£5,000 (from parent to child) £2,500 (to grandchildren or great grandchildren) £1,000 (to anyone else getting married)
Gifts to spouses and civil partners	Unlimited (with a limit of £55,000 on the IHT-free gift when it is from a domiciled to non-domiciled spouse/civil partner)
Regular gifts from income	Unlimited (gifts must be from surplus income, be habitual and be documented
Lifetime gifts to individuals	Unlimited (the donor must survive for seven years after the gift is made for it be IHT-free, so the date of the gift must be recorded)

Life insurance
Life insurance policies held in trust means that death benefits are excluded from the estate and are IHT-exempt.

Wills
An estimated 50 per cent of Britons fail to make a will, but a well-drafted will is a valuable IHT planning tool. All adults should make a will, which should be reviewed regularly. A new will must also be made on marriage, civil partnership or divorce.

Beneficiaries can change a will by mutual consent up to two years after a death, which can be particularly useful where IHT is concerned.

Equalising estates
Married couples or civil partners should make sure that they each have sufficient assets to use up their respective nil-rate band of £300,000 on their death if they are transferring assets to other people.

Nil-rate band discretionary trust wills
A will that sets up a nil-rate band discretionary trust allows married couples or civil partners to pass on assets up to the nil-rate band of £300,000, giving the survivor access to the assets without them becoming part of their estate.

Equity release
An equity release scheme can free some of the value tied up in a home, which can then be tax-efficiently gifted. Although potentially useful in some cases, they need to be considered carefully.

AIM shares and portfolios
Shares held in companies trading on the Alternative Investment Market (AIM) are not liable to IHT after they have been held for two years. 

Discounted gift schemes
Discounted gifts schemes allow someone to give money away while retaining access to a regular, predetermined income for life. Based on factors including age and level of income selected, there is usually an immediate IHT and further savings if the donor survives for seven years.

Other options
Agricultural and business property – such as an office or working farm – may be exempt from IHT once they have been owned for two years.

Significant works of art and heritage property may be IHT-exempt if available for public viewing. Some assets can be used to pay IHT liabilities.

Gifts to registered charities – and political parties – can be made free of IHT.

Trusts
Trusts are a well-established and useful tool in estate planning. Trusts allow someone (the settlor) to make a gift of assets, without completely losing control of those assets, by placing them with a third party (the trustees) to administer on behalf of the trust beneficiaries.

Their value in IHT planning is that they allow people to reduce the wealth on which they will pay inheritance tax without making a valuable outright gift – something they might be reluctant to do if the potential recipients are quite young or might take an irresponsible approach to a substantial sum of money, for example.

The trust allows wealth to be passed on in a tax-efficient manner, under the control of the trustees, who can include the settlor.

There are different types of trust. Some give the trustees very little discretion, but can be useful when the aim is to establish the future use of assets. For example, a will trust could give a widow the right to certain income, with the capital passing to any children on her death.

Other trusts, known as discretionary trusts, allow the trustees to retain control of the assets under the terms of the trust, which set out when and what the beneficiaries receive. They can also allow the trustees to react to changes in the beneficiaries’ circumstances. Again, the settlor can be named as a trustee.

The ages of estate planning
It’s always a good time to start thinking about inheritance tax planning, although your needs and goals - and the steps you take - will depend on your age.
In fact, your life can be divided into four key stages when it comes to inheritance tax planning, with your age dictating the most appropriate action.

The first age
You’re young and building your career, with a young and growing family. Your living expenses include the mortgage on your family home and are likely to be high.
At this stage, your financial priorities will probably be to plan for school or university fees, pay off your mortgage and save for a comfortable retirement, but there are two important steps you can take towards inheritance tax planning.

• Put in place an inheritance tax protection policy. This should be written in trust for beneficiaries other than your surviving spouse or civil partner.

Being written in trust means that the proceeds of the policy do not form part of your estate for inheritance tax purposes, so the beneficiaries will receive a tax-free sum to help meet your inheritance tax bill. Such polices are available for a fairly modest monthly or annual premium.

• Make sure that you have a well-drafted and flexible will that makes use of your IHT allowance. This simple, affordable step is also an opportunity to look at how estates are held between married couples or civil partners. The will should always be kept up to date.

The second age
In middle age, you may well have assets that take you well over the inheritance tax threshold. Or you may be a successful entrepreneur, thinking about retirement.
At this stage, your financial priorities will be to reduce the value of your estate – to minimise your inheritance tax bill – while keeping enough capital and income so that you can enjoy a comfortable standard of living.  At this age, your inheritance tax planning could include:

• Taking steps to protect your family home through options that enable the potential inheritance taxpayer to stay in the property, while removing a large proportion of its value from their estate.

Every individual situation is different, so professional financial advice is essential to decide on the best way forward.

• Setting up a lifetime discretionary trust, allowing you (the settlor) to place certain assets into a trust administered by trustees (the legal owners of the assets).

You retain control over what happens to those assets by the terms of the trust, which sets out when and what the beneficiaries receive. You can also name yourself as a trustee.

• Succession planning for business owners.  It is essential that you prepare for the smooth transition of your business to a new owner, while also preserving any available inheritance tax business property relief (BPR).

The third age
You are elderly and perhaps suffering from ill health. You have not had the opportunity to put IHT planning into place, but there are still options for reducing your tax liability.

• Making use of the gifts that are exempt from IHT, which could add up to a sizeable sum each year.
• A well-drafted and flexible will can significantly reduce your inheritance tax liability or even remove it completely.

The fourth age
The final stage is post-death planning. The inheritance tax planning option here is:

• A deed of variation, which can be used if a will was not as tax-effective or flexible as it could have been, or if no will was left (intestacy).

The deed allows the estate to be distributed tax-effectively, with new gifts being treated for inheritance tax purposes as if they had been made in the will. The deed must be put in place within two years of a death, and be agreed to by the relevant beneficiaries.
Such a deed can be a good way to divert wealth when beneficiaries are already wealthy and do not wish to make their own inheritance tax position more difficult.

Conclusion
Inheritance tax planning is complex but is certainly worth investing time and money to protect your current and future family wealth, to make sure that those you love are well taken care of when you are no longer around.

Seeking professional advice is a wise move, as is reviewing your plans regularly, to keep them up to date with your personal circumstances and tax or legal changes.

For more information on how Harris Lipman can help, please email InfoAccounts@harris-lipman.co.uk or call (020) 8446 9000.

 

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