As property prices make inheritance tax (IHT) more of a reality for many in the UK, Marianne Curphey looks at a number of ways to prudently manage your estate to mitigate against what is sometimes referred to as the ‘voluntary’ tax.
In times gone by, ‘death duties’ were associated with the decline of the English country house, with some of Britain’s finest homes severely hit by the cost of paying tax to the Government as they passed down from one generation to the next.
These days, IHT can hit families with even quite modest assets – including those who have been basic rate taxpayers all their lives. IHT is an unpopular and controversial tax, coming as it does at a time of loss and mourning.
It can be difficult to accept that you have to pay tax on your estate – which has usually been accumulated out of taxed income – and that your heirs will not reap the full rewards of your hard work.
However, many people who end up paying IHT do so because they have failed to put their financial affairs in order in advance. If you plan proficiently neither you nor your heirs may have to pay IHT at all.
IHT is levied at a fixed rate of 40% on all assets worth more than £325,000 per person – or £650,000 per couple if other exemptions cannot be applied.
However, following the Chancellor’s Summer Budget in July 2015, it was announced that from 2017 parents and grandparents will be able to leave property worth up to £850,000 to their children without them having to pay IHT. This figure will rise to £1 million by 2020.
The current allowance of £325,000 remains unchanged but a new tax free band worth £175,000 per person on your main residence only will be added to the £325,000 making it £500,000 per person. The new tax free band will be set at £100,000 in 2017 before gradually rising to £175,000 in 2020.
There are effective and legitimate ways to mitigate against IHT, which is why it is sometimes called the ‘voluntary tax’. Unfortunately, some of the most valuable exemptions must be used seven years before your death to be fully effective, so it makes sense to consider ways to tackle IHT sooner rather than later.
Dying intestate (without a will) means that you may not be making the most of the IHT exemption which exists if you wish your estate to pass to your spouse or civil partner. For example, if you don’t make a will then relatives other than your spouse or civil partner may be entitled to a share of your estate and this might trigger an IHT liability. We offer a Will Writing Service, provided by law firm Hugh James (Brodies LLP in Scotland), and can act as your Executor and manage the administration of your Estate which can then relieve the pressure and stress from your family at a very difficult time.
Gifts made more than seven years before the donor dies, to an individual or to a bare trust (see types of trust), are free of IHT. So it might be wise to pass on some of your wealth while you are still alive. This will reduce the value of your estate when it is assessed for IHT purposes, and there is no limit on the sums you can pass on. You can gift as much as you wish, and this is known as a Potentially Exempt Transfer (PET). However, there is a catch: if you live for seven years after making such a gift, then it will be exempt from IHT, but should you be unfortunate enough to die within seven years then it will still be counted as part of your estate if it is above the annual gift allowance. You need to be particularly careful if you are giving away your home to your children with conditions attached to it, or if you give it away but continue to benefit from it. This is known as a Gift with Reservation of Benefit.
Being generous to your favourite charity can reduce your tax bill. If you leave at least 10% of your estate to a charity or number of charities, then your IHT liability on the taxable portion of the estate is reduced to 36% rather than 40%.
Family trusts can be useful as a way of reducing IHT, making provision for your children and spouse, and potentially protecting family businesses. Trusts enable the donor to control who benefits (the beneficiaries) and under what circumstances, sometimes long after the donor’s death. Compare this with making a direct gift (for example to a child) which offers no control to the donor once given. When you set up a trust, it is a legal arrangement and you will need to appoint ‘trustees’ who are responsible for holding and managing the assets. Trustees have a responsibility to manage the trust on behalf of and in the best interest of the beneficiaries, in accordance with the trust terms. The terms will be set out in a legal document called ‘the trust deed’.
BARE (ABSOLUTE) TRUSTS: The beneficiaries are entitled to a specific share of the trust, which can’t be changed once the trust has been established. The settlor (person who puts the assets in trust) decides on the beneficiaries and shares at outset. A simple and straightforward trust – the trustees invest the trust fund for the beneficiaries but don’t have the power to change the beneficiaries interests decided on by the settlor at outset. Offers potential income and capital gains tax benefits, particularly for minor beneficiaries.
LIFE INTEREST TRUSTS: Typically one beneficiary will be entitled to the income from the trust fund whilst alive, with capital going to another, or other beneficiaries, on that beneficiary’s death. Often used in will planning to provide security for a surviving spouse, with the capital preserved for children. Can also be used to pass income from an asset onto a beneficiary without losing control of the capital. Can be particularly attractive in second marriage situations when the children are from an earlier marriage.
DISCRETIONARY (FLEXIBLE) TRUSTS: The settlor decides who can potentially benefit from the trust, but the trustees are then able to use their discretion to determine, who, when and in what amounts beneficiaries do actually benefit. Provides maximum flexibility compared to the other trust types and for this reason is often referred to as a Flexible Trust.
Contact your Private Banking and Advice Manager to look at your inheritance tax needs together with other areas of your finances to arrive at an appropriate strategy for you.
For further information on setting up a trust you can contact your Private Banking and Advice Manager. We offer a wide range of inheritance tax advice and trust solutions to suit your individual needs, which can include acting as a professional trustee through our Trust Management Service.
Tax treatment depends on individual circumstances and may be subject to change in the future. The information given is not intended to provide legal, tax or financial advice.
Contributor Marianne Curphey is a freelance financial journalist published in both national and international titles. Views expressed by all contributors are their own. All information is correct as at September 2016.
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