Inheritance Tax (IHT)

Not everyone pays Inheritance Tax. It is only due if your estate – including any assets held in trust and gifts made within seven years of death – is valued over the current Inheritance Tax threshold (£325,000 in 2010-11).
The tax is payable at 40 per cent on the amount over this threshold.

What is Inheritance Tax?
Inheritance Tax is usually paid on an estate when somebody dies. It’s also sometimes payable on trusts or gifts made during someone’s lifetime. Most estates don’t have to pay Inheritance Tax because they are valued at less than the threshold (£325,000 in 2010-11). 

Increased threshold for married couples and civil partners
Since October 2007, married couples and registered civil partners can effectively increase the threshold on their estate when the second partner dies – to as much as £650,000 in 2010-11. Their executors or personal representatives must transfer the first spouse or civil partner’s unused Inheritance Tax threshold or ‘nil rate band’ to the second spouse or civil partner when they die.

Who is responsible for paying Inheritance Tax?
Inheritance Tax is payable by different people in different circumstances.
Typically, the executor or personal representative pays it using funds from the deceased’s estate.

Introduction to Inheritance Tax planning
Planning ahead for when you die allows you to set out clearly who should get what from your estate. It also means you can maximise Inheritance Tax reliefs and exemptions if your estate might be worth more than the Inheritance Tax threshold when you die (£325,000 in 2010-11).

The importance of making a will
Making a will and being sure people know where to find it is the first step to ensuring that your estate is shared out exactly as you want it to be when you die.

If you don’t leave a will, your estate will be shared out among your next of kin according to a strict order of priority called the ‘rules of intestacy’. This means that people you want to benefit from your estate – such as a partner you’re not married to or in a registered civil partnership with – might get nothing. The rules are different in Scotland. If you would like a will writer to come to your home Veracity Financial Planning can recommend a trustworthy firm.

Inheritance Tax exemptions – what you can give away
Gifts are treated in a number of ways for Inheritance Tax purposes. However, you only need to worry about making gifts if you think your estate – including the value of any gifts you make – might exceed the Inheritance Tax threshold when you die. If your estate is over the threshold, any gifts you make more than seven years before you die will be exempt from Inheritance Tax.

Property
It is difficult to give away your Home or put your Main Residence Property in trust if you continue to live there because this would be unravelled by HMRC as a “Gift with reservation” – ie not really given away as you continued to enjoy the benefit – (you could of course pay an arms length market value rent which would get over this problem)

Other Assets
You can give away any amount of money or asset value without a trust, this should be documented and dated as a gift and provided you survive 7 years after the date of the gift then this value has left your estate.
The main area of concern here is if gifting to children who are or may marry in future, there is no protection from assets being threatened by divorce.
In order to protect against this hazard a trust can be established so that neither the person giving away, nor the potential beneficiaries actually own the assets, as the trust acts as a separate identity. However the gift to the trust stills has to pass the 7 year rule to be completely out of the estate

Trusts
The Gov’t has cracked down on trusts with a vengeance to ensure that it doesn’t lose out on tax revenue.
If more than the Nil Rate Band is given away recent rulings enforce IHT being paid before Death at half the death rate. So any amount given away to a trust over the nil rate band value (currently £325,000) is immediately taxed at 20% being the lifetime IHT rate. Followed by 10 year anniversary tax charges and exit charges.

Exempt Beneficiaries
Transfers of assets to certain beneficiaries are exempt from Inheritance Tax. They include:-

• UK domiciled husband and wife
• UK domiciled civil partner
• Certain national institutions e.g. The National Trust, national museums and universities
• UK registered charities
• UK political parties

HMRC website explains domicile as having “no precise or agreed definition. Broadly speaking, under English law you are domiciled in the country in which you have made your permanent home.

Exempt Gifts
Some gifts are exempt because of the type of gift. Gifts made in consideration of marriage or civil partnership are exempt up to the following amounts:-

• £5,000 for a gift from a parent
• £2,500 for a gift from a grandparent
• £1,000 for a gift from any one else

Small Gifts
Small Gifts are exempt up to the value of £250, and you can give it to as many people as your want. This exemption can not be used in conjunction with any other exemption

Annual Exemption
Each tax year you are allowed to gift away up to £3,000. Any part of this which is unused from a previous tax year can be carried forward to the next one. So you can give away £6,000 if you have not used the previous year’s £3,000 allowance.

Gifts from normal expenditure Gifts that you make out of your income after tax are also exempt provided you can maintain your previous standard of living from the balance of your net income, (i.e. where it is not a gift from your capital). Regular payments coming from single premium life bonds associated with either a Discounted Gift Trust or Loan Trust are not eligible for exemption under normal expenditure rules. It would need to be part of your regular expenditure, and would include:-

• regular or monthly payments such as University or School fees for a child in full time education
• the regular premiums for a life insurance policy

Potentially Exempt Transfers (PETS)
Most gifts which are not exempt are usually Potentially Exempt Transfers (PETs) if made to an individual or certain types of trust. For the PET to become totally free of  Inheritance Tax you would need to live for seven years after the date of the gift, and not retain any interest in the gift (i.e. you can not gift your house but continue to live in it, as this would be a Gift With Reservations).

The Inheritance Tax liability on a PET reduces on a sliding scale, this is called Taper Relief. The details are below:

0-3 yrs       0
3-4 yrs      20%
4-5 yrs      40%
5-6 yrs      60%
6-7 yrs      80%
7+ yrs       100%

The importance of keeping records
• It will help your executor or personal representative to sort out your financial affairs when you die if you keep a record of any gifts you make and note on that record which exemption you’ve used.
• It’s also a good idea to keep a record of your after-tax income if you make regular gifts out of income as part of your normal expenditure. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Insurance
If there is a known IHT liability then an insurance policy can be taken out to cover the liability to protect the beneficiaries.

There are two ways of doing this:

1/ Whole of Life: Insure the total liability, where date of liability (death) is unknown a whole of life policy can be affected which will ultimately pay out on death.
here there are two forms “Maximum Life Cover” and “Balanced Life Cover”
“Maximum Life cover” is initially cheaper as all premiums go towards life cover. However there will be a 10 year review at which time the premium will increase, sometimes substantially.
“Balanced Cover” is initially much more expensive but is unlikely to increase in price at review as part of the premium is invested to go towards increased costs as you get older.

2/ 7 Year Rule/ Gift Intervivos: If a gift is given this value will not leave the estate for 7 years.
A 7 year insurance policy covering the tax liability of the gift will cover the tax liability immediately.
A Gift Intervivos Policy will reduce in line with the 7 year rule making the insurance policy cheaper – however this only works on gifts over the nil rate band, any gift upto the nil rate band must be insured on a 7 year level term. (this is because when gifts are assessed they are used to fill up the Nil Rate Band first and taper relief is not allowed within this element – therefore only gifts above the Nil Rate Band receive taper relief)

Example of Taper Relief
Joe made a gift of £350,000 on 15 January 2006. He died on 15 April 2009. The Inheritance Tax threshold for the year he died is £325,000.
Follow the steps below to work out the Inheritance Tax due:
Step one: take away the threshold from the value of the gift: £350,000 − £325,000 = £25,000. So Inheritance Tax is due on £25,000
Step two: work out the Inheritance Tax at the full rate of 40 per cent: £25,000 × 40 per cent = £10,000
Step three: the gift was made within three to four years of death. So Taper Relief at 20 per cent is allowed: £10,000 × 20 per cent = £2,000
Step four: take away the Taper Relief from the full tax charge: £10,000 − £2,000 = £8,000
In this example, Taper Relief reduces the amount of tax payable from £10,000 to £8,000

Veracity financial planning is not responsible for, nor does the Financial Services Authority regulate advice given with regard to taxation matters regard to trusts; some aspects of tax advice; commercial mortgages or second charge secured lendin.
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