Inheritance Tax

Only estates above a certain value attract Inheritance Tax (IHT), and the threshold is raised each year at the time of the Budget.  However, rising UK property values have brought the estates of an increasing proportion of home-owners within the scope ofIHT. The IHT rules are complicated, so it is important to take advice from professionals when you make your will. Rather than rushing to give away money or property in order to minimise the tax, you need first to ensure that you have enough for yourself, or for your partner in the event that you die first. Your money, or the value invested in your property, if you own any, might for example be needed to pay for long-term care when you are older.

However, for those who are comfortably off and would like to
investigate the possibilities of minimising IHT, some of the key points are briefly outlined below.

The Inheritance Tax threshold or nil-rate band

Everyone is allowed to leave a certain amount before Inheritance Tax is payable. For 2008–9 this amount, known as the nil-rate band, is £312,000 throughout the UK.

For married and civil partnership couples, provided that at
least one partner was living on 9 October 2007, there will
be additional (now known as ‘transferable’) nil-rate band on the death of the second of them if the first did not fully use his or her amount.This is calculated by finding out what proportion of the estate was not used on the first death. For example, if, now, on a first death the chargeable estate (the amounts passing to anyone other than spouse or civil partner and charities) is £156,000 and the nil-rate band is £312,000, 50 per cent of the nil-rate band would not have been used. If, when the second death occurs, the nil-rate band has increased to £325,000, the second estate would be entitled to its own nil-rate band plus a further 50 per cent of the current amount (not the rate at time of first death):

i.e. £325,000 plus £162,500 = £487,500 in total.

In terms of practicalities, this means that clear records of the
figures involved on the first estate should be carefully kept so
that the claim to additional exemption can easily be calculated. Without such records, problems could occur, particularly where the first death occurred before 9 October 2007. It is highly advisable to seek professional advice about Inheritance Tax issues, as it is a very complicated area.

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Gifts and transfers

If your estate is valued at more than the nil-rate level there are many other ways by which you may be able to reduce the amount of tax payable on your estate while you are still living. For example, the following are free of IHT:

• gifts of money or possessions (£3,000 per year, and any number of smaller gifts of £250 or less);
• gifts made from your income and which are paid regularly; and
• gifts to charities (see ‘Definitions of assets in a will' below).

If you go beyond these limits you will not immediately be liable to Inheritance Tax on the gift, and you do not normally even have to tell HM Revenue & Customs.

However, you will probably have made a Potentially Exempt
Transfer (see below) and there may be a tax liability on it on
your own death.

Note that a crucial condition that applies to all gifts, particularly
of property and land, is that they can be exempt from Inheritance Tax only if you retain no beneficial interest whatsoever in the gift: for example, you could not receive any profits from shares you have given away.

Some gifts are only potentially exempt from Inheritance Tax;
only after seven years is no IHT payable.These gifts are called Potentially Exempt Transfers (PETs). If you die within seven years of making the gift a system called taper relief (reducing tax liability) determines the amount of tax payable. This means that if you have made the gifts in excess of the nil-rate band (hence subject to IHT) and you die after three years, from the fourth year the IHT liability is reduced by 20 per cent each year, so that after seven years no Inheritance Tax would be due at all. Great care is needed with PETs.They are not as straightforward as they may appear, and it is possible that an apparent Inheritance Tax saving may not be allowed as such by HM Revenue.

If you die within seven years of making a PET its value when the gift was made will be taken into account in calculating the Inheritance Tax on your estate.Taper relief applies after the third year, but only if you have made gifts above the Inheritance Tax threshold, and does not therefore have much application in practice.

It should be noted that gifts made in your lifetime take advantage of the 0 per cent tax rate available within the nil-rate band.They may therefore be free of tax themselves, but cause additional tax to be payable by the beneficiaries under your will.

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Giving away property

For most people their home is their most valuable asset, and the one that brings many people into the Inheritance Tax bracket. Your prime concern should be to safeguard yourself, and your partner, rather than to minimise IHT for those who will inherit from you. However, if your home becomes too big for you to cope with, or deteriorating health means that you need to move to another type of accommodation, you may wish to consider passing it on to your children or grandchildren, unless of course you decide to sell it and buy another property.

You can transfer the ownership of your main residence to
someone else, but there could be problems in the future if
you are still benefiting from it.This is not a problem if you have
moved to more suitable accommodation, but if you continue to
live there, even for fairly short periods, the gift of the property
will be subject to Inheritance Tax unless you pay rent at the
market rate to whoever you have given it to.

If you have a second home that you no longer use you may
consider transferring it to one of your children or grandchildren. However, again, you must not retain any benefit from it. You can still visit, but if you stay for extended periods any relief from Inheritance Tax may be lost unless you pay a full rent for using it.  There will be implications for the beneficiary too; if they receive an asset, such as a property, it could well affect any benefits they were entitled to. It is therefore worth getting advice on what the best arrangement will be.

This is also a complex area because although steps can be taken to minimise Inheritance Tax, Capital Gains Tax can become an issue. Always take professional advice before making any decisions about what to do with property.

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Insuring against Inheritance Tax

Many insurance companies offer policies to offset the amount
of Inheritance Tax that will be payable on estates.As with other
types of insurance, you pay a monthly premium while you are
living so your beneficiaries should have less to pay when you die.

In short, there are many ways of making tax savings but in
most cases there are stringent conditions, so you should seek professional advice to make sure you are benefiting from all the available allowances.

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Definitions of assets in a will

Legacies are gifts of money or property left to someone in
a will.They can be left to either individuals or organisations.
Chattels are tangible, movable property such as the following:

• furniture
• works of art
• crockery, silverware, jewellery
• motor vehicles
• plant and machinery that is not permanently fixed.

Residue: The residue of an estate is everything that is left when bequests and legacies have been distributed and any debts and other liabilities settled.

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Trust funds

Putting assets into a trust fund is a means of leaving part or all of your estate to someone, or a group of people such as grandchildren, while retaining control of the fund. It is also a useful way of providing for the education of grandchildren. Although there will be an Inheritance Tax liability it will be a lot less than if you gave the money as a direct gift.

Trust funds are also an appropriate way of providing for relatives who are disabled, or in need of support because they are not able to look after themselves.

The people who look after the assets in trust are the trustees (see Planning your will) Ideally, they will work closely with the guardians, whose responsibility is the general welfare, education and development of the beneficiary.

The person who drafts your will should help you decide on the limits of the trustees’ powers and how much flexibility they have. The aim should be to make enough money is available through a regular arrangement to look after the beneficiary’s general needs while allowing the trustees the flexibility to allocate extra funds if and when the guardians feel this is necessary. For example, a disabled person may need to purchase medical equipment such as a specialised wheelchair.

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Types of trust

There are four main types of trust, all designed to cater for different needs and with varying tax benefits. They are normally defined as:

• Bare trusts. These are very straightforward. The trustees hold whatever assets are in trust until the time you have decided they should be released. The beneficiary then has the right to take full possession of them.
• Life interest trusts. In this kind of trust the assets, which may be property or money, are held for the eventual benefit of someone, but they will not receive the assets until the person with the ‘life interest’ (normally your spouse or civil partner) has died. The interest earned from the capital is paid to the person with the life interest as it arises, or can remain in the fund. If the asset is a property, you can give it to your children (for example), but stipulate that your spouse or civil partner is to be permitted to live there for the rest of his or her life. On his or her death the trustees will release the property or other assets to the beneficiary.
• Discretionary trusts. These give the trustees general power to allocate the funds in trust at any time as they see fit, according to the needs of the beneficiaries. Or they can let interest accumulate and invest the capital so that the fund grows. The time (or age) after which the beneficiaries may have assets released to them by the trustees is specified in the will.
• Trusts for bereaved minors. These have replaced accumulation and maintenance trusts as a means of passing on assets to children while retaining control of the fund. Prior to the April 2007 Budget it was possible to stipulate that children would not inherit until they reached the age of 25, but there may now be additional Inheritance Tax to be paid on larger trusts if you wish to postpone entitlement to that age.

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Special trusts

Two special trusts are treated differently from the ones mentioned above and have preferential taxation arrangements:

• Charitable trusts for giving away large sums of money, where the trust qualifies as a charity. The charitable status needs to be approved by the Charity Commission.
• Disabled trusts for looking after those who, due to mental incapacity, are not able to look after their own affairs. This kind of trust can also be used for the benefit of someone who qualifies for Attendance Allowance or Disability Living Allowance.

Taxation of trusts

How a trust is taxed, and what tax applies (Inheritance Tax, Capital Gains Tax or income tax) depends on a number of factors, such as the nature of the assets which make up the trust, when the assets were put into trust, the value of other aspects of the estate that may not be in trust etc. Also, the income from a trust fund, the interest on capital invested, and profit gained from the sale of property in trust is taxable. There are strict rules to ensure that trust funds are not used as a tax evasion tool, and complex equations for calculating any tax payable. These are beyond the scope of this guide and require professional advice.

Note that a gift to a trust is not a PET and may give rise to
immediate Inheritance Tax. It is very important to take
professional advice before making any gifts into trust.