Inheritance Tax
Inheritance Tax Planning
At Fairey Associates one of our key areas of advice is inheritance tax. As a nation we are all getting wealthier whilst the nil rate band has not been increased as fast by successive governments. Inheritance Tax planning is a complicated area of advice in many ways because it is multi disciplinary. Planning in this area requires good legal advice but, in order to consider the full range of options, good financial and investment advice is also of key importance.
The following article describes as clearly as possible some of the key planning strategies that you can be used to take advantage of a number of tax exemptions and products to ensure that the maximum amount of wealth is passed to the next generation, without impairing the lifestyle that you’re used to.
The Basics
As a minimum the following basic planning principles should be considered first as part of any IHT solution:
Deed of variation
If you have inherited assets within the last two years, a deed of variation can be used to remove them from the estate with immediate effect.
Nil rate band planning using an up to date will
Married couples and civil partners can leave a legacy, equivalent to the value of their individual nil rate band in their will. A discretionary trust can be used to prevent the value of one spouse's/civil partner's estate falling into the estate of the surviving spouse/civil partner. This utilises the nil rate band of the first partner to die and doesn't increase the potential IHT liability of the surviving spouse/civil partner. Such planning could provide a potential IHT saving of £124,800 (£312,000 @ 40%) based on the 2008/2009 nil rate band.
Maximising Exemptions and Pension contributions
You can reduce the value of their estate for IHT purposes by:
- Using your annual IHT exemption – it's currently possible to give away £3,000 a year without incurring a liability to IHT. The exemption may be carried forward for one year, but will be subsequently lost if it's not used.
- Making gifts on marriage or civil partnership – exempt gifts can be made to someone entering into marriage or a civil partnership. The amount of exemption depends on how the person making the gift is related to the bride, groom or civil partner.
- Normal expenditure out of income – exempt gifts of any amount can be made as long as they’re made from surplus income and they do not detract from the standard of living of the person who is making the gift.
- Making or increasing pension contributions - a highly tax efficient way of reducing the value of an estate.
Access
Once the basics are in place you may well be faced with the classic IHT dilemma – you’ve got an estate worth more than the nil rate band, but can't make a gift of capital as you rely on it and/or the income arising from it.
If you face this dilemma there are two solutions which should be considered:
Loan Trust
This is a solution for those who want flexible access to a certain amount of capital.
You (the settlor) lend funds (capital) to a trust created for family members or friends to benefit from. These loaned funds (the capital) are then invested to provide an income and/or capital growth but the settlor can access the capital at any time should this be necessary.
Any income or growth arising on the investment is immediately outside of the settlors’ estate for IHT purposes as you only have access to the outstanding loan (capital).
Discounted Gift & Income Trust
This may be appropriate where you don't need access to capital, but do require a fixed income each year.
Here the settlor makes a gift of funds to a trust they've created for family members or friends to benefit from and retains an absolute right to an income. Income is paid until the settlor dies or the fund has been exhausted, which ever happens first.
The value of the gift made to the trustees may also be discounted for IHT purposes depending upon the settlors’ life expectancy and the amount of income they choose to receive.
LIFETIME GIFTS
If an IHT liability remains after you’ve accessed the income or capital you need to maintain your current standard of living, you may want to take advantage of the favourable taxation of lifetime gifts. This involves you making a gift without retaining access to it, in short giving money away. You may be able to make a gift to an individual or a trust that, from an IHT perspective will be treated as either a potentially exempt transfer (PET) or a chargeable lifetime transfer (CLT).
If the gift isn't covered by an exemption, you will need to survive seven years for the value of it to fall outside their estate for IHT purposes.
ALTERNATIVE SOLUTIONS
If none of these solutions are suitable, and you are still left with an IHT liability, it may be necessary to consider alternatives.
You could take out a life insurance policy to fund for the anticipated IHT liability. Or, you may want to consider investing in assets that qualify for an IHT relief, such as business property relief and/ or agricultural property relief. For example assets such as shares in unquoted trading companies (including Alternative Investment Market (AIM) stock portfolios) would provide an inheritance tax efficient, albeit a high risk investment.