Inheritance Tax

Advice for people worried about Inheritance Tax

The Chancellor announced, on the 9th October 2007, that the Inheritance Tax allowance would be transferrable between husband and wife. Most reports instantly got this wrong by announcing that the nil rate band had increased to £600,000; it hadn't.

In the past, unless either the husband or wife in a married couple (or equivalent in a civil partnership) passed their nil rate band outside their estate more than 7 years before their death, then this allowance would come back into calculation and therefore effectively be lost. Whilst each individual had a £300,000 allowance, it was not transferable between partners as above. For the 2008-09 tax year, the nil rate band has been increased to £312,000.

What has changed is that now it is transferable. Immediate implications are that, for example, where a house is worth £600,000 and is jointly owned, there is no longer any need to sever joint tenancy and effect Discretionary Will Trusts in favour of the family with the remaining spouse having the right to remain in the property, as the unused £312,000 nil rate band of one spouse can be transferred to the other.

It was also announced that this would be retrospective for widows and widowers.

It is still not transferable between co-habitees and single people still only have a £312,000 allowance. If you are divorced and not widowed, your nil rate band is still £312,000.

Even if that means that fewer people will now be caught by Inheritance Tax, the way house prices have soared over the last few years, especially here in Norfolk and Suffolk where we operate, means that relatively modest households can still be affected.

Let us not fool ourselves - Inheritance Tax is still a complex area where you need professional help. Click here or on the button in the right hand border to go to our Inheritance Tax Contact Form. Whilst we are based in Norwich and operate primarily in Norfolk and Suffolk, we can also offer a national service.

Inheritance Tax affects more and more people, most of whom never dreamed that their “estate” was an “estate”, nor that the family home that they had sometimes struggled to keep together would one day be a source of revenue for the Exchequer rather than a source of wealth that they could pass to their children and grandchildren.

Everyone has an Inheritance Tax nil rate band of £312,000 (2008/2009 tax year). This will increase to £350,000 in 2010. In addition there are annual allowances which haven’t changed for years and whilst they haven’t become exactly meaningless, they have faded in significance:-

• £3,000 can be given each year to anyone (you can “mop up” 1 years unused allowance

• £250 can be given to any number of people (but not to the recipient of the £3,000)

You can make some generous wedding gifts

• £5,000 to your children

• £2,500 to your Grandchildren

• £1,000 from anyone else

Payments for the maintenance of your spouse, ex-spouse, dependent relatives and, usually, your children who are under 18 or in full-time education will also be exempt from Inheritance Tax.

The flat rate of Inheritance Tax over the nil rate band is 40%. Transfers between husband and wife are free of Inheritance Tax. In the past, leaving all you owned to your spouse might have seemed the most obvious choice but all it meant in reality was that you forewent your own nil rate band.

In 2004 the Capital Taxes office took steps to close certain loopholes that existed previously and some dubious Inheritance Tax avoidance schemes will either be undone and be subject to Inheritance Tax or will suffer the Pre-Owned Asset Tax (POAT). Schemes caught by this legislation included “double trust” arrangements where everything was put into one name with a spouse as a trustee/beneficiary, then some time later the election removed so that the person setting up the arrangement could also enjoy the income. This will not work any more.

A number of legitimate Inheritance Tax mitigation schemes do remain and after estates are equalised where possible, that is to say assets owned between husband and wife are held in roughly equal proportions, then, if the surviving spouse would be able to manage financially on the death of the partner, these assets can be distributed to the family either in the lifetime of the donor or on death, using a Will Trust.

This arrangement can even work with the family home, providing the trust has been set up properly. Older trusts are unlikely to be robust in light of the Revenue’s tougher stance on such matters.

The March 2006 Budget saw major changes to the treatment of some trusts in relation to lifetime transfers. There has subsequently been some amelioration in the Finance Act, but extreme care needs to be taken with both existing and new trusts. Working in combination with your solicitor, our financial services expertise is invaluable.

Other schemes, briefly, are:-

Discounted Gift

These schemes split invested capital into two trusts. The first gives a right to income for the donors and the remaining capital forms the second trust property. Income must be specified at the outset and this first trust falls outside the estate at once. The remaining trust property becomes a “Potentially Exempt Transfer”, which means that it will fall outside the estate after 7 years. The size of the first trust depends on age and state of health, but for someone investing £100,000 into such a scheme could see £65,000 outside their estate from day ! And the remainder free from Inheritance Tax after 7 years AND enjoy income of up to £5,000 a year, with no further income tax to pay. This type of scheme can be particularly effective if done in conjunction with an Equity Release plan.

Loan Trusts

Sometimes called Gift and Loan Trusts, although the Gift  part is not strictly necessary these days. This arrangement works where you do not want to lose control of your capital but would like to build up funds outside your estate free of  Inheritance Tax, for the benefit of your family or other beneficiaries.

The donor provides the trustees with a lump sum as an interest free loan. This is normally invested in a single premium bond. The growth in this investment accrues to the trust outside your estate, whilst capital remains inside the estate. The loan is then repaid gradually to the investor. This can be done by 5% per annum withdrawals from the bond for up to 20 years which the investor can use as "income" on which no income tax will be payable.

The remaining capital can also be withdrawn if required. At death, any outstanding loan is also returned to the donor's estate and is potentially liable for Inheritance Tax. Once you have decided on the amount of capital to which you may require future access, the larger the initial gift the sooner this capital falls outside of your estate.

Discretionary Will Trusts

These can use a variety of investments, but the most suited for most of these types of arrangement are single premium investment bonds, owing to their unique taxation treatment. Solicitors draft your Wills so that whoever dies first gifts their bond into a Discretionary Trust created by the Will, including the surviving spouse and the children as the beneficiaries.

Whilst you are both alive, you can take withdrawals from their bonds in the normal way. After the first death occurs, the bond belonging to the first to die falls out of their Estate for Inheritance Tax purposes (up to the £312,000 nil rate band), and the Trustees of the Will Trust could use their discretion under the Trust to pay sums to the surviving spouse from the bond which had been effected by the deceased. Any gains arising from policies in the Will Trust will escape tax if the tax year in which the gains arise is after the tax year in which the person making the Will (the testator) died

Potentially Exempt Transfers (PETS)

Provided that you live for a further seven years, you can make more tax free gifts. The range of gifts qualifying as PETs was reduced in the March 2006 Budget and now gifts that meet the criteria for PETs are: Absolute gifts to another individuals, gifts into Absolute or "Bare" Trusts and gifts into trusts for the disabled. If you set any of these up seven (or more) years before you die, they are non-taxable.

If you die within the seven year period, then the PETs. are included in your total estate, and the Inheritance Tax is chargeable at the usual rate (your first £312,000 tax-free, then 40% after that).

If the gift that you with to give is valued at more that £312,000 alone then you must apply a tapering tax to the gift, depending on the total value and period since the gift was given, you will still only be taxed on the amount over £312,000

Alternative Investment Market Schemes

Utilising the tax breaks that come with such schemes, it is possible to remove the amount invested from your estate after 2 years from investment. However, these are high risk investment schemes whose values can fluctuate wildly and which may not be very liquid investments when you need to realise capital. Whilst they may indeed have a place and application, this might just be a case of the tax tail wagging the dog! One golden rule we always hold to is never to invest just for the tax break

Asset Investment Management is an Independent Financial Adviser (IFA) based in Norwich. Inheritance Tax and Estate Planning, formerly called Death Duties. Advice for Norfolk and Suffolk on Inheritance Tax and the nil rate band.