Inheritance tax is something most people do not worry about but probably should - given the way house prices have risen over recent years. As a result of soaring property prices many individuals and couples will find that they have been pushed over the current threshold. For those with concerns tax planning is essential.
You only have to begin paying IHT at a certain point. The 2009/10 threshold for married couples and those in civil partnerships is now £650,000 following the Chancellor's announcement in his pre-Budget Report last October. For individuals the threshold remains at £325,000, but this will rise over the coming years to £350,000. The joint married couples IHT limit will be raised to £700,000 from 2010.
If the value of your estate, including your home and certain gifts made in the previous seven years prior to your death, exceed this figure, tax will be due on the amount of your estate over the threshold at a rate of 40%.
Your estate includes everything owned in your name; your share of anything owned jointly; gifts from which you benefit from or any assets held in some trusts from you receive an income.
Against this total value is set everything that you owed at the time of your death such as, any outstanding mortgages or loans, unpaid bills, and costs incurred during your lifetime for which bills have not been received, as well as funeral expenses.
Any amount of money may be given and not counted for tax providing that you live for seven years after making this gift. These type of gifts are called 'potentially exempt transfers' and are useful for tax planning providing that you can afford to give the money away without deliberately depriving yourself.
Money put into a 'bare' trust - a trust where the beneficiary is entitled to the trust fund at age 18, counts as a potentially exempt transfer, so it is possible to put money into a trust to stop grandchildren, for example, having access to it until they are older.
However gifts to most other types of trust will be treated as chargeable lifetime transfers. Chargeable lifetime transfers up to the threshold suffer no tax but amounts over are taxed at 20% with a further 20% payable if the person making the gift dies within seven years.
Any gifts between husbands and wives or civil partners are exempt from IHT whether they were made while they were both still living or left to the surviving spouse on the death of the first. Tax will be due eventually when the surviving spouse dies if the value of their estate is more than the tax threshold of £650,000.
Some cash gifts are exempt from tax regardless of the seven-year rule. They include:
- Wedding gifts of up to £5,000 to each of your children;
- Wedding gifts of £2,500 to each grandchild, and
- Wedding gifts of £1,000 to anyone else;
- Other annual gifts of up to £3,000 a year (plus any unused balance of £3,000 from the previous tax year);
- Gifts of up to £250 each to any number of people each year;
- Gifts to charities, the National Trust, national museums, the main political parties and most registered housing associations.
Regular gifts from after-tax income, such as a monthly payment to a family member, are also exempt as long as the giver still has sufficient income to maintain their standard of living.
If gifts are made that affect liability to IHT and the giver dies less than seven years later, a special relief known as taper relief may be available. The relief reduces the amount of tax payable on a gift.
- In most cases, IHT must be paid within six months from the end of the month in which the death occurs. If not, interest is charged on the unpaid amount. Tax on some assets, including land and buildings, can be deferred and paid in instalments over 10 years. Though if the asset is sold before all the instalments have been paid the outstanding amount must be paid. The IHT threshold in force at the time of death is used to calculate how much tax should be paid.
- Make a plan
Think about where you want your money to go and why. Many people have reservations about giving away assets too quickly.
Work out if inheritance tax will be an issue by adding up the value of your savings, investments, property and personal possessions. Do not forget personal equity plans (Peps) and individual savings accounts (Isas) - though they are tax-free during your lifetime - they form part of your estate for IHT. Finally, take off the value of any debts. If the total adds up to more than £650,000 for a married couple or £325,000 for an individual then IHT will apply.
- Write a will
Your Will makes your wishes known and clarifies who should get what. It will stop any assets being divided under the rules of intestacy, where even spouses are not guaranteed to inherit everything. It can also be the first step to reducing an inheritance tax bill. The aim is to give the option for both husband and wife to use their full inheritance tax allowance on death.
- Minimise your estate
You cannot be taxed on money that was never yours. So ensure that as much as possible is outside your estate. Write any new life insurance plans under trust. Many existing life policies can be transferred into a trust. If your employer pays a death benefit, complete a nomination form to make sure any money goes directly to the person you choose and not into your estate. It is also worth thinking about legacies you receive. Someone who benefits from a legacy can divert that gift to another person.
- Get married
Anything you pass on to a spouse is free of inheritance tax. The same concession applies to same-sex couples who register under civil partnership laws.
- Think about your home
For many families, their homes are their biggest asset - and their biggest inheritance tax headache. The Government has clamped down on schemes to get around the 'gifts with reservation' rules. These allowed people to give away homes, but still live in them. Now, income tax can be charged for living rent-free in a home you once owned. You will be advised on what can be done in relation to your home to aid in IHT planning.
Some investments are given favourable treatment for IHT purposes, including shares in unquoted businesses, woodlands, farms and farmland. Many shares on the Alternative Investment Market (Aim) junior stock market also qualify for relief.
- Explore trusts
Aside from Will trusts, several other types of trust can help in estate planning. Depending on the type you choose, it can still be possible to enjoy an income from money paid into trust, even though you are no longer the legal owner of that money. Specialist advice from LCS and their associate IFA is essential for anyone considering setting up trusts.
- Pay tax in instalments
Another option is to estimate how big an IHT bill your Executors face then arrange insurance to cover part or all of it. Whole-of-life insurance written under trust can provide a lump sum on death that is outside an estate.
Upon death, the proceeds of the policy can be used to settle the tax bill. The premiums are treated for tax purposes as a gift from regular income. Think of this as building a fund to pay your tax. The advantage is that you retain your wealth through your lifetime and so have the funds if, for example, you need to go into long-term care.
- Spend it
Do not lose sight of whose money it is in the first place. If you are worried your wealth is simply building up a tax bill, then throw off the shackles and enjoy yourself.