Inheritance Tax & Estate Planning Advice
Inheritance Tax is a popular topic with financial advisers and their clients, because it is an area where just a short conversation can save the client thousands.
For those prudent enough to discuss their Inheritance Tax planning with their adviser, Inheritance Tax is known as ‘the most avoidable tax of all’.
For those who neglect to put the simple keystones in place to avoid Inheritance Tax, however, it is ‘the tax for those who love the Revenue more than they love their own children.’
As an individual, you have an Inheritance Tax threshold, a tax-free allowance for passing wealth on to your heirs. This is known as the ‘nil rate band’, because within this band Inheritance Tax does not apply. In 2009/10, the nil rate band is £325,000 for a single person, and £650,000 for a couple. If your total wealth goes above those levels, however, it stands to incur Inheritance Tax at 40%.
Tax planning for your ‘estate’
The Inheritance Tax thresholds named above may sound generous, but it must be remembered that they apply not only to your property – they apply to your ‘estate’, which includes much more besides.
Your estate consists of the value of your home and any other properties you may own (holiday home or buy-to-let properties), your cars, and other assets, investments, savings and insurances that pay out upon your death. These are then reduced by your debts and liabilities (e.g. paying off a mortgage, loan and credit card debts, and funeral costs), to give the net value of your estate.
Suddenly, the Inheritance Tax threshold doesn’t sound so generous any more!
Take for instance a simple example of a widow with a home valued at £250,000, insurances totalling £200,000, and debts of £50,000. Her total wealth upon her death would therefore be £450,000, less her debts of £50,000, giving £400,000 as the net value of her estate. Her Inheritance Tax threshold allows the first £325,000 to pass to her children tax-free, but the remaining £75,000 is subject to Inheritance Tax at 40%. This means that her children must pay £30,000 of their inheritance to the taxman – which, with a little tax planning, might have been totally avoidable.
In order to avoid Inheritance Tax her adviser could, for example, have set up her life insurance policies ‘in trust’. This would have meant they were no longer regarded as part of her estate. That way, she would have had no tax liability to worry about at all.
Inheritance Tax Planning with Trusts
Trusts are an effective tool in planning to minimise your Inheritance Tax liability.
A trust is a legal relationship whereby you (the ’settlor’) transfer your assets (the ‘trust fund’) to another individual (the ‘trustee’), who might typically be your brother, sister or close relative. You will also be a trustee of the company, and will normally nominate one or two further trustees, bringing the total to three or four. The trustees hold and manage the assets for the benefit of others – the ‘beneficiaries’ – as named by you, the settlor. The trustees are bound by the terms of the trust deed, which is based on your instructions, and directs them as to how they must administer the trust.
Trusts can hold assets such as money, investments, land or property, and even antiques and valuables. By placing these in a trust, they are removed from your estate, and no longer count towards the total valuation of your wealth with regard to Inheritance Tax. Furthermore, you can stipulate that the assets in the trust are not transferred over to your children immediately upon your death. They can remain there, for example, until your children turn 18, or indeed longer, according to your instructions.
There are three main types of trust.
With a ‘bare trust’, your beneficiaries are entitled to the contents of the trust at age 18. However, this counts as a ‘potentially exempt transfer’ that is not automatically free of Inheritance Tax. It is subject to the ‘7-year rule’, which dictates that you must survive 7 years after setting up this arrangement, before the tax exemption is applied. If you die before the 7 years have elapsed, then Inheritance Tax will apply.
A ‘discretionary trust’ allows the trustee to decide who benefits from the contents of the trust. In other words, you have left no specific instructions, and the trustee decides who gets what.
A ‘discounted gift trust’ allows you to make gifts into a trust, while continuing to draw an income from those gifts.
The area of planning for Inheritance Tax and estate planning is complex, and the advice of a qualified expert is essential. Nonetheless, good planning is vital when it is relatively easy to vastly reduce your Inheritance Tax Liability.
In short, an hour spent discussing Inheritance Tax with your financial adviser could be the best-paid hour of your working life!
