INHERITANCE TAX PLANNING

WHAT IS INHERITANCE TAX?

Inheritance tax has been described as a voluntary tax paid by those who distrust their heirs more than they dislike the Inland Revenue. Yet, more than £2bl per annum is collected in inheritance tax.

WHEN IS IT PAID?

A charge for inheritance is made when someone dies or when a transfer is made to a Discretionary trust or to a company. In respect of deaths on or after the 6th April 2003 the threshold is £255000. An estate up to this amount is charged at a nil rate
and the surplus is charged at 40%.

WHAT IS AN ESTATE?

A person’s estate is the total of everything that they own in their own name and also their share of everything owned jointly.
Also included are any gifts with a reserved benefit such as a home being gifted away but still living there.
Assets held in a trust from which they receive an income would also be chargeable.
The liability to pay inheritance tax falls on the executor or administrator and is due six months after the end of the month in which death occurred. Late payment will incur interest charges.
It is obvious that full use is not being made of the available relief’s and exemptions and steps that can be taken to reduce or eliminate the tax completely are as follows;

WHAT ACTION CAN BE TAKEN?

Make an efficient will! This is the most basic step in planning.
Lifetime gifts will reduce the value of your estate during your lifetime. One type of gift that should be considered is a Potentially Exempt Transfer (PET) if you survive 7 years from the date of the gift, it is not included in the estate for inheritance tax. Taper relief to reduce the value of the gift would apply before the end of 7 years. To qualify as a PET the gift must be outright and unconditional.

WHAT EXEMPTIONS ARE AVAILABLE?

Please note that exemptions are available for certain classes of gift as follows;
Wedding gifts of up to £5000 to each of your children, which includes stepchildren and adopted children, or the person that your child is marrying.
Wedding gifts of up to £2500 to each grandchild or the person that your grandchild is marrying.
Wedding gifts of up to £1000 to anyone else.
Payments for the maintenance of your husband or wife, ex-husband or ex-wife, dependent relatives and, usually, children under 18 or in full time education.
Other gifts up to the value of £3000 in any one tax year plus the unused balance of £3000 from the previous tax year. The tax year is from the 6th April to the following 5th April.
Outright gifts in any tax year up to a total of £250 each to any number of people, but only if the total of any gifts made by you to the recipient in the same tax year does not exceed £250.
There is no inheritance tax payable on lifetime gifts or gifts on death between spouses, but both must be domiciled in the UK
All outright gifts and bequests to UK registered charities are free of inheritance tax.
Any bills outstanding at death, including funeral expenses.

WHAT ABOUT MARRIED COUPLES?

Married couples are treated separately for inheritance tax and each have their own Nil Rate Band (NRB). This means that there is no IHT payable if all the estate is left to the surviving spouse. Unfortunately, the NRB of the deceased is lost and could cause an additional IHT charge on 2nd death. Therefore by not utilising the NRB an additional charge of £102000 could occur i.e. 40% of £255000 on the second death.

SOLUTION 1

If all or part of the NRB is left to the children on first death no IHT would be due on element passing to children and the estate on 2nd death has been reduced, which means a potential saving of £102000 on the second death.
Still, many people who make wills leave all the estate to the surviving spouse. Possibly, there is a concern about leaving considerable assets to children and a loss of control and access to the surviving spouse. If such a concern exists, it is possible to utilise the NRB on first death and still allow access to the surviving spouse.

SOLUTION 2

Discretionary Will Trust---On 1st death the Executors will transfer cash or assets up to the amount of the NRB to the Trustees to be held under the terms of the Trust. For maximum efficiency each spouse owns assets to the value of the NRB. The Trustees would be the surviving spouse and adult child with a professional Trustee. Beneficiaries would be children, grandchildren and the surviving spouse. Because a Discretionary Trust is set up on first death. The value of the Trust fund would not be included in the survivor’s estate for IHT. Any balance of the estate left to the surviving spouse on first death would be free of IHT under the spouse exemption. Generally, financial security for the surviving spouse is essential so the Trustees should have power to pay income or capital and/or make loans to the surviving spouse. It is also possible to arrange for the surviving spouse to receive the assets that were meant for the Discretionary Trust as a loan, in return for a promise to repay the Trust on his/her death. For maximum IHT saving the will should also take account of;
Alterations in the NRB;
Other gifts or legacies that could reduce the NRB;
If not married at the date of death the assets should bypass the Discretionary Trust;

WHEN IS IT SUITABLE?

The Discretionary Will Trust may be suitable for married couples,
Who have no liquid assets or Life Assurance Bonds;
May not be certain about who to name as beneficiaries;
May wish to retain full and unrestricted access to their assets during their lifetimes.

SOLUTION 3

Lifetime Nil Rate Band Trust; ----This is a similar system to the Nil Rate Band Trust except that the assets are transferred to the Trustees during the Settlor’s lifetime. The Trustees will have power to appoint capital to the Settlor. Because an Interest In Possession exists, the Settlor will be entitled to any income produced by the Trust fund during his/her lifetime. The Settlor is treated as owning the Trust capital and therefore no IHT liability occurs when the trust is set up. The Trust property will form part of the Settlor’s estate on death. The default beneficiaries are usually children or grandchildren and so the NRB can be fully utilised on his/her death. Any excess over the NRB is left to the surviving spouse and the inter spouse exemption applies so that no IHT is payable on the first death.
The Trustees may appoint all or part of the trust capital to one or more of the Discretionary Beneficiaries. In addition, loans can be made to the widow/widower which has the effect of increasing the IHT advantage of the arrangement.

COMPARING SOLUTION 2 AND 3

When deciding which is the most suitable arrangement to suit particular circumstances, it is obvious that the same amount of IHT can be saved by either method. The Settlor has access to the Trust Funds during his/her lifetime and funds are available to the surviving spouse.

ADVANTAGES OF THE LIFETIME NIL RATE BAND TRUST

It may be in favour of the Lifetime Nil Rate Band Trust that no Probate is required so that funds are immediately available and it is not dependent on a will, which might be contested on the first death. In addition, this an Interest in Possession Trust so there are no periodic and exit charges.

WHAT TYPE OF ASSET IS SUITABLE?

A suitable investment for the Lifetime Nil Rate Band trust would be a non income producing Life Insurance contract such s a Capital investment Bond. This can be linked to a range of investment funds which may be managed internally or externally.
Some advantages of this investment would be that;
No liability to income tax unless a chargeable gain occurred,
Withdrawals of up to 5% of the original investment can be made annually from the bond without any immediate liability to income tax. Any unused allowance may be carried forward for use in later years.
There is no capital gains charge on profits.
Production of Probate is not required on investor’s death.

MAXIMUM FLEXIBILITY

Usually a bond can be written on more than one life and can be divided into segments, which produces maximum flexibility.

ANY OTHER SOLUTION?

When all the necessary steps have been taken to mitigate the IHT liability and a liability still exists, the best course of action is to make arrangements for a fund to be available on the second death in order pay the amount due. This is normally achieved by means of a 2nd death Whole of Life contract which is written on the lives of husband and wife and payable on the second death. The cost of this contract would depend on age and state of health at the time the contract is affected.

FOR INDIVIDUAL SOLUTIONS

To enable precise information to be provided, complete the Inheritance Tax Questionnaire attached.