Inheritance tax planning - avoiding unnecessary tax - by independent financial adviser John Bramwell

Inheritance Tax Planning

What is Inheritance Tax?

When you die, all your assets are added up to give the total value of your estate. Inheritance Tax (IHT) is then charged at 40% on the part of your estate above a certain level and is paid by the beneficiaries of your estate.

This means that for every £100,000 that your estate exceeds this level, then £40,000 must be paid to HM Revenue & Customs.

IHT is not charged when your estate passes directly to your spouse.

When do you pay IHT?

If your estate goes over the Nil Rate Band*, which is £312,000 (for 2008/2009), then it will be liable for inheritance tax. Some other allowances may be made, eg. for recent gifts, and these will reduce the amount of tax due, though probably not by much.

As property prices are ever increasing, many more estates now exceed the £312,000 Nil Rate Band and so are subject to IHT. In many cases the value of a house alone exceeds the Nil Rate Band.

* List of nil rate bands for previous years.

How can you avoid IHT?

IHT is often called a 'voluntary tax' because it can be avoided, with suitable forward financial planning.

The most effective way of eliminating IHT is to give sufficient assets away at least seven years before you die, so that the final value of your estate will fall below the Nil Rate Band. Also, various allowances, such as the annual gift of £3,000 or certain gifts on marriage, can all be used to reduce your estate.

However, it is impossible to judge when you have only seven years left, and in any case it is not always possible to give away enough assets to prevent your estate incurring IHT. For example, you may need the assets to live off.

In addition, the 'gift with reservation' rules mean that any gifts made from which you gain some benefit are ignored, and the full value of the gift remains in the estate for IHT purposes. Such gifts include your home if you continue to live in it.

Previously any unused nil rate band from a deceased spouse or civil partner was lost, but it was announced in the October 2007 Pre-Budget Report and confirmed in the March 2008 Budget that up to 100% of the unused proportion of a deceased partner's nil rate band can be claimed on the death of the survivor, if the death occurred on or after 9th October 2007. This effectively gives couples an allowance of £624,000 and means that previous methods of ensuring that the nil rate band of each partner was used (such as changing home ownership from 'joint tenants' to 'tenants in common' and drawing up suitable wills to place some or all of the assets into trust) will not be required.

How can I use my assets to give me an income yet still avoid IHT on my estate?

At first sight it can be difficult to see how IHT can be avoided, as many people wish to keep control of their own assets in case they need them in the future, for living expenses, residential care, etc.

The solution is to use one of the several kinds of trusts available. Placing assets into trust means that you can give assets away but retain access and control, to varying degrees, via the trustees of the trust.

This is a complex area but effectively means that, providing you survive seven years, assets can be moved from your estate (to eliminate IHT liability) and you can keep some access to them without falling foul of the 'gift with reservation' rules.

What other options do I have?

You can purchase life insurance that is designed to pay the IHT when it becomes due.

You can do nothing and let your estate pay the IHT, but would you really prefer the Revenue & Customs to benefit rather than your family?

Your house is often your largest asset and options involving this can also be considered. These include:

Moving to a smaller property.
Giving your home to your beneficiaries and then paying market rent.
Releasing capital from the house using various equity release schemes.

Some of these options complement each other. For example, if you placed an investment in trust (to remove the capital from your estate but retain an income from it) you could cover the potential IHT over the next seven years (until the gift was exempt from IHT) by using a seven year life insurance policy. Similarly, if you moved house to a smaller property you could use the released capital for outright gifts and/or gifts into trust and again make use of life assurance over the following seven years.