Inheritance
Tax
Inheritance
Tax (IHT) is a combined gift tax and death duty. It applies to gifts
and deemed gifts made during a persons lifetime and to his estate
on death. Currently the first £275,000 of Chargeable Transfers (Nil
Rate Band) is charged at 0% and is therefore free of IHT. Any transfer
in excess of this amount which takes place either at death or within
seven years of death is taxed at 40%.
There
are a number of exemptions
eg. an annual exemption of £3,000 (with the possibility to go back and
make a further £3,000 payment for the previous tax year if it remains
unused). There is also an exemption for marriage gifts and the payment
of £250 small gifts exemption. Regular gifts out of normal income can
also be exempt. One of the main areas of exemption is gifts between
husband and wife, which is normally unlimited. It is this area which
requires attention in most cases, as between them, a husband and wife
have an exemption of up to £550,000
but often the appropriate planning has not been put in place.
INHERITANCE
TAX PLANNING FOR MARRIED COUPLES
Is
your joint estate (including your house) more than £275,000? Yes?
Then you could have an Inheritance Tax Liability.
Usually
an individual can leave an estate of up to £275,000 (the Nil Rate
Band) without incurring Inheritance Tax. Any surplus above this amount
may be taxed at 40%. Irrespective of value, anything a husband and wife
leave to each other is exempt from tax when the first of them dies as
long as they are UK domiciled. If you do no tax planning and leave everything
to each other and then, on second death, to your children, you could
pay more tax than you need to.
For
example:
Assume
that you each have assets of £275,000 giving a total joint estate
of £550,000
and the husband dies first:
In
this example the husband's nil rate band is wasted. As mentioned
above, transfers between spouses are nearly always exempt but he
has missed the opportunity to pass assets tax free to a non-exempt
beneficiary e.g. the children.
A
simple solution to save tax of £110,000 would have been for the
husband to leave the £275,000 of his estate directly to
his children and not to his wife.
| Husband
dies |
 |
Children
receive £275,000 |
| Then
wife dies |
|
Children
receive a further £275,000 making a total of £550,000
tax free. |
The
caveat here is that when her husband dies, the wife does not benefit
from his estate as it has all passed to the children. If this were
to have an adverse effect on her standard of living it may not be
a practicable option.
An
Effective Solution
Could
be for each spouse to draw up a will instructing that an amount
up to the then current nil rate band be left in trust when he/she
dies. The trust would be created by the will and should be a Discretionary
Trust. The potential beneficiaries of the trust should include
the surviving spouse and the children, but with the appointment
of benefit left to the discretion of the Trustees.
The
key here is to make the surviving spouse one of the potential beneficiaries
of the trust. The surviving spouse can also be made one of the Trustees
of the Trust (although this is not recommended if the loan scheme
described below is envisaged). The Trustees may decide that the
surviving spouse needs some or all of the assets and may make an
appointment of benefit to him/her. Alternatively, they may appoint
all the assets to the children.
If
the surviving spouse has need of the trust fund, it would make sense
to arrange to take an INTEREST FREE LOAN from the trust which is
REPAYABLE ON DEMAND. This would provide the required use of the
trust assets but would also create a DEBT against his/her estate.
The trustees can ensure the debt is not called in during his/her
lifetime.
On
his/her death, the loan is repaid to the trust and then appointed
to their children tax free, as it falls under the nil rate band
exemption of the first spouse to die. The estate of the second spouse
to die is reduced by the debt and the balance is passed to the children
tax-free if it falls within his/her nil rate band exemption.
Eg.
| Husband
dies |
|
Leaves
£275,000 in a Discretionary Trust with his wife as one of
the potential beneficiaries |
Trust
loans wife
£275,000 |
|
Wife
has use of capital of £550,000 |
| Wife
dies |
|
Loan
repaid to trust |
|
Children
receive trust proceeds plus mother's estate potentially Tax
free |
Result:
Children receive £550,000 tax-free BUT wife has been allowed the
opportunity to benefit from her husband's capital during her lifetime.
The
Inland Revenue
At present the Inland Revenue is not challenging this method of
letting the surviving spouse benefit and still save tax. However,
this may alter in the future hence any Will needs to be as flexible
as possible to enable it to cope with future changes. It should
also be able to cope automatically with any increase or decrease
in the Inheritance Tax exemptions which may change each year.
Jointly
Held Assets
If your property and investments are held in joint names, usually
they will automatically pass to the surviving spouse and will not
be governed by your will. Normally they could not, therefore, pass
into a will trust and would simply be added to the estate of the
surviving spouse. It may be possible to avoid this by changing the
ownership of the assets, for example:-
(a)
Your House
Most couples who own their domestic property do so as "joint
tenants". This means that the share of the first to die will
pass automatically to the survivor. If the basis of ownership were
changed to "tenants in common" it would mean that on first
death, the deceased's share of the property could be transferred
into the discretionary trust with the surviving spouse retaining
the ownership of his/her share only but also, potentially, enjoyment
of the deceased's share of the property as a beneficiary of the
trust.
However,
this strategy has potential pitfalls.
-
if the deceased has left his/her share of the property to trustees
and the surviving tenant in common is a potential beneficiary
of the trust, that survivor's continued sole occupancy of the
property could enable the Revenue to deem that the deceased's
share of the property had passed into the estate of the surviving
spouse for Inheritance Tax purposes and would remove any tax planning
benefit.
-
in any event, the Inland Revenue is increasingly hostile to the
use of the matrimonial home for Inheritance Tax planning, and
this makes the whole subject potentially risky for planning purposes.
Any implications of an interest in possession in the whole property
may be used as grounds for charging Inheritance Tax on the whole
property by the Inland Revenue on the second death.
- control
of the property may be compromised by the conflicting interests
of a younger generation, possibly able to force the surviving
tenant in common out of the property and into alternative accommodation.
-
there could be a loss of capital gains tax principal private residence
relief on the half of the property acquired by a new, non-occupying,
owner and a liability to CGT could therefore start to accrue from
the date of the first death.
(b)
Other Assets
Assets held in joint names cannot be brought into the tax-planning
device outlined above. If it can be done conveniently, you should
try to separate assets into individual ownership. But do consider
whether the tax saving is actually worth any inconvenience this
causes.
Lifetime
Gifts
Another way of avoiding Inheritance Tax is to make an outright gift
to the following generation(s). Various exemptions are available.
For example, there is no liability to Inheritance Tax on lifetime
transfers to individuals (or to certain but not all, kinds of trust)
as long as the donor lives for a further seven years after which
time the value of the gift would be completely out of his/her estate.
Death within the seven year period would mean that the gift would
be brought back into the estate for Inheritance Tax purposes and
could potentially be taxable.
Life
Assurance
The simplest solution to most Inheritance Tax problems is to take
out a second death whole of life assurance policy to cover the amount
of the Inheritance Tax liability. The policy should be written in
trust and its proceeds paid via the trustees to the beneficiaries
of the will to enable them to settle the tax bill, leaving the estate
to pass intact to the desired beneficiaries.
The
premiums for second death policies are relatively cheap and can be paid
either monthly, yearly or as a lump sum. Using this solution, the parents
retain ownership of their house and assets during their lifetime, the
taxman still gets paid and the children can still receive the full value
of their parents' estate.
Conclusion
With careful planning, you can save up to £110,000 in Inheritance
Tax if your joint estates total £550,000. Tax is due only on the
death of the second of the spouses to die at the rate of 40% on the
excess over the nil rate band, currently £275,000. It has been
said that the planning opportunities available mean that Inheritance
Tax is a voluntary tax. Do you really want to be an Inheritance Tax
volunteer?
Although
your personal estate may be less than £275,000 it could grow to
exceed this amount and/or the nil rate band threshold may be lowered
in the future.
If
Inheritance Tax is an area of concern to you, you should have your
Wills reviewed by a solicitor who specialises in Inheritance Tax
and Trusts in association with your Independent Financial Adviser
who should be able to advise you on the investment aspects of any
trust property and also explore the much simpler, Life Assurance
option.
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This
information is based on our understanding of current tax law and
Inland Revenue practice which may be subject to change in the future.
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