Inheritance Tax – The forgotten tax
Many people don’t place inheritance tax high on their list of priorities. However, recent figures indicate that HMRC receipts from inheritance tax have increased from £2.72 billion in 2010/2011 to £2.91 billion in 2011/12 with the number of estates that paid inheritance tax also increasing from 3,000 to 20,000 (source: Personal Finance Society April 2013).
Now is the time to ensure that your children or other beneficiaries receive as much as your estate as possible if you pass away.
What is Inheritance Tax?
Inheritance tax is a tax imposed on an individual – usually the beneficiary who inherits a property or money after their relatives have died.
Currently, if an individual has assets worth more than £325,000 (including cash held in deposit, savings accounts and the family home) any amount over £325,000 will be subject to 40% tax. Married couples have a combined nil-rate threshold of £650,000 with the surviving spouse being able to transfer any used allowance from their deceased spouse.
Nobody likes the idea of their family losing up to 40% of their money in taxes. But that’s what can happen. When you die, HM Revenue & Customs can claim 40% of your estate above the threshold of £325,000 (the tax free allowance for the 2014/15 tax year).
So what can I do to reduce the amount of tax my beneficiaries will have to pay?
There are some important inheritance tax exemptions that allow you to make gifts to others without having to pay tax on them when you die, such as:
You can give away up to £3,000 in each tax year. These gifts will be exempt from inheritance tax when you die. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don’t use it in that year, the carried-over exemption expires.
The annual exemption is in addition to other gift exemptions.
You can make small gifts up to the value of £250 to as many people as you like in any one tax year. However you can’t gift a larger sum and claim exemption from for the first £250.
You can’t use the small gift allowance together with any other exemption when giving to the same person.
Regular gifts or payments that are part of your normal expenditure
Any regular gifts you make out of your after-tax income, not including your capital, are exempt from inheritance tax. These gifts only qualify if you have enough income left after making them to maintain your normal lifestyle.
- Monthly or regular payments to someone
- Regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries
- Regular premiums on a life assurance policy for you or someone else
Potentially Exempt Transfers – The seven year rule
Any gifts you make to individuals will be exempt from inheritance tax as long as you live for seven years afterwards. These sorts of gifts are known as Potentially Exempt Transfers (PETs).
However, if you give an asset away at any time, but keep an interest in it – for example if you give away your house but continue to live in it rent free – this gift will not be a potentially exempt transfer as it would be considered a gift with reservation.
If you die within seven years and the total value of gifts you made is less than the inheritance tax threshold, then the value of the gifts is added to your estate and any tax due is payable out of the estate.
If you die within seven years of having made a gift and it is worth more than the inheritance tax threshold, inheritance tax will need to be paid, either by the person receiving the gift or by the representatives of the estate.
If you die between three and seven years after making the gift, and the total value of the gifts that you made is over the threshold, any inheritance tax due on the gift is reduced on a sliding scale. This is known as taper relief. Taper relief is only applied to the amount over the inheritance tax threshold.
Full details of all exemptions can be found on the HMRC website: www.hmrc.gov.uk/inheritancetax/pass-money-property/exempt-gifts.htm
Financial & Legal Inheritance Tax Planning (IHT)
Financial & Legal Inheritance Tax Planning is one of the most effective ways to mitigate the liability of your estate. Some solutions even allow part of your estate to be exempt from Inheritance Tax from day one of implementing the advice.
Below are examples of some of the favourable financial products we can help you take advantage of:
Discounted Gift Trusts
A discounted gift trust is very useful for IHT planning as:
- It allows you to choose the people who you wish to inherit your assets, rather than HMRC
- Liability is potentially reduced as soon as we have implemented it
- It provides a fixed regular income for the life of the plan
A discounted gift trust is divided into two elements:
- The discount (based upon life expectancy and level of regular withdrawals)
- The gift (investment amount less discount)
The discount element deemed to be outside of your estate for Inheritance Tax Purposes is effective upon implementation, whilst the gift will be disregarded after seven years of the investment being placed. After seven years, the full amount placed into the trust is outside your estate for Inheritance Tax purposes.
A discounted gift trust is suitable for people who:
- Have assets above the nil rate threshold (£325,000 for 2013/14) and are concerned about the liability to Inheritance Tax on their estate
- Wish to increase the level of regular income they receive
See our case studies for examples of how this product may work for you.
Many people are not aware, but assets which qualify for Business Property Relief (BPR) become fully exempt from Inheritance Tax once they have been held for a period of two years.
An aim portfolio invests your money in a spread of companies that are listed on the Alternative Investment Market. Provided the shares are held for a minimum of two years, the original investment plus any subsequent growth will fall outside your estate for IHT purposes. These are relatively straightforward investment plans which means that the holders are free to unwind them or cash-in part of their holdings at any time.
The schemes capitalise on a tax rule which states that any assets held in an unquoted company qualify for 100 per cent Inheritance Tax Business Property Relief (BPR) after just two years.
The downside to an AIM portfolio is that the capital is not guaranteed. All equity investments carry a degree of risk but Aim-listed shares are slightly more sensitive since the companies are predominantly smaller and could suffer more when consumer confidence falls.
Careful consideration should also be given to the shares held as not all of the companies listed on the Alternative Investment Market qualify for Inheritance Tax Business Property Relief. There is no definitive list available to guide investors.
These types of portfolios are only really suitable for individuals who have a large amount of liquid assets that they do not want to include in their estate, and which they are prepared to subject to a higher investment risk.
Appropriate planning can save your estate, but more importantly, your children or beneficiaries tens of thousands of pounds.