Step One – the basics
Making a Will is vital – particularly if you are not married. If you die “intestate” (without a Will) your estate will be divided up according to the rules of intestacy. This is particularly important if you are not married because a “common law” spouse is unlikely to inherit partner’s money, or even their share of the home.
For example, in England & Wales, your legal spouse only receives chattels and £250,000 plus a life interest in half the remainder of your estate; your children receive the balance at age 18. If you have no children, your spouse receives chattels plus £450,000 plus a life interest in half the remainder; your parents or siblings receive the balance. If you have no spouse and no children, your estate passes to your parents or then your siblings. If you have no legally recognised family, your estate goes straight to the Crown.
Step Two – use your allowances
You may gift up to £3,000 annually without being liable for Inheritance Tax, and unused allowances can be carried forward for one year. You may also make an exempt gift when someone gets married, this is £5,000 for parents of the bride or groom, £2,500 for grandparents and £1,000 for anyone else.
Regular gifts out of income are exempt from inheritance tax provided they do not adversely affect the donor’s standard of living. This provides a myriad of planning opportunities.
Gifts to charities are exempt from Inheritance Tax.
Step Three – using trusts
Trusts have long been perceived as an easy way of brushing off an Inheritance Tax liability. If this was ever the case, it changed after the 2006 Budget, which closed down many planning opportunities. Under the new rules, Interest in Possession (IPP) and Accumulation & Maintenance (A&M) Trusts became subject to the same rules as Discretionary Trusts.
Transfers into IPP and A&M trusts over the donor’s nil rate band (currently £325,000) are subject to an upfront 20% inheritance tax charge, and liable to a periodic charge of up to 6% every 10 years. Despite this, these trusts are still very useful planning tools as they allow the nil rate band to be gifted every seven years without giving rise to inheritance tax.
Review your existing life assurance and pension policies; check that they are written under appropriate trusts to ensure that death benefits are not paid into your estate where they will become subject to inheritance tax.
Step Four – consider life assurance
Life assurance can be a useful way to facilitate enough money to pay your inheritance tax bill when it arises. The policy is funded from “regular giving pattern” premiums which are usually exempt from inheritance tax, but it is essential that the policy is written in trust so that the proceeds fall outside your estate.
Step Five – consider tax favoured investments
Certain investments in businesses and smaller company shares are tax favoured when it comes to inheritance tax, provided that they have been held for two consecutive years in the past five years.
Some, such as Enterprise Investment Schemes, also attract income tax relief and favourable capital gains tax treatment. These investments however, will not be suitable for everyone, as they carry considerable risk to the capital invested – hence the favourable tax treatment. It is essential to seek Independent Financial Advice before embarking on these types of investment so that the risks can be tailored to the requirements of individual investors.
Summary
There are numerous opportunities for individuals trying to mitigate the effects of inheritance tax. Advice, timing and planning are essential in this area, where the old adage, “if you fail to plan, you plan to fail” holds true. Unfortunately the cost of failing to plan usually has four or more zeroes on the end.
Contact Robin Clarke to review your inheritance tax position; robin@bluecoatwm.com or 01273 466533
