New figures from Aviva reveal why Inheritance Tax (IHT) is one of the most important sources of revenues for the UK taxman.
There are currently £2.5 trillion in assets earmarked by parents as inheritances for their children and relatives, the insurer announced this week.
This staggering sum is held by two-thirds of over-55s covered by an Aviva survey*, with 58% of those questioned wishing to bequeath assets to their family and 46% mentioning specifically the family home as the principal asset they will leave.
Given that Inheritance Tax applies to all eligible wealth at 40%, you can see why the taxman might be rubbing his hands with glee.
However, any financial adviser worth his salt will tell you that, with a little financial planning, Inheritance Tax is the most avoidable tax of all, and can be minimised or eliminated completely by putting the correct structures in place.
Each person has an Inheritance Tax allowance of £325,000 (double that for a couple to £650,000). Where the value of your wealth exceeds that allowance, it is subject to Inheritance Tax at 40%.
While these ‘nil rate band’ allowances seem generous, they apply to your whole estate.
This consists of your home, other properties, savings and investments, insurance policies, other assets, and cars. Take away the amount of your debts and liabilities upon death, and you have the net value of your estate.
Life insurance in trust
By using a trust you can move assets out of your estate, so that their value does not push your net worth up towards the threshold at which you become liable for Inheritance Tax.
By filling out a simple form when taking out a life policy, you can hold the life insurance in trust so that the cover does not inflate the value of your estate. An added advantage is that the payout from the life insurance policy will not be held back upon your death, but paid quickly and efficiently to your family.
Inheritance Tax exemptions
One tax-savvy way to transfer wealth to your children is by making gifts that are not subject to Inheritance Tax - so-called Inheritance Tax exemptions.
There are various kinds of IHT exemptions, subject of course to the limitations of the Inheritance Tax allowances:
- Spouse exemptions
- Small gift exemptions, of up to £250 to any number of persons in a given year
- Annual exemptions to your children of £3,000 per year
- Wedding exemptions of £5,000 to a child or £2,500 to a grandchild when they marry
- Regular gifts of a ‘reasonable size’ to be classed as part of your normal expenditure – for instance maintenance payments or funds for a child in full-time education
There are also a number of ‘potentially exempt’ gifts, known as potential exempt transfers or PETs.
These are only ‘potentially’ exempt because they are not immediately free of tax. You must survive for 7 years after making the gift, before it becomes tax exempt. In other words, a gift made in 2010 becomes tax-free only if and when you have survived until 2017.
The most common PET is probably the family home, transferred to your children and becoming tax-free 7 years later.
There is one important catch with regard to transferring your home, however. If you continue to benefit from the home, by living there, it is classed as a ‘gift with reservation’ and is still subject to tax.
This can be avoided if you set up an arrangement to pay your children rent at a commercial rate, in which case you are viewed as a tenant.
Source: Aviva online poll of 1,337 UK adults
