Inheritance Tax - Don’t Get Caught Out!

The following notes are from a presentation given by Geoff Mason of Geoff Mason Associates in association with Dashwoods Limited on Wednesday 23 February, 2005.

What is Inheritance Tax

Inheritance Tax (IHT) is a tax payable on Death...

...if an individual's Chargeable Asset Value
LESS
Liabilities (Debts)
LESS
Nil Rate Band Relief
EXCEEDS
The Nil Rate Band (£263,000 in 2004/05)

Nil Rate Band:	in 2001/2 was £242,000
	in 2004/5 is £263,000

An Increase of 8.67% over 3 years

Putting it into Perspective

The Average Price of a detached house in Parts of High Wycombe rose from

Jan – Mar 2001 to Jan – Mar 2004

£240,404 to £369,000

% Price Increase of 53.86% over 3 years

Inheritance Tax Due (excluding any liabilities):

2001	2004
Nil	£45,960

This above figure excludes any Additional Asset Value

The Importance of Making a Will

Avoids Intestacy and the complicated rules that apply in these circumstances
Makes Sure the Money Goes to the people you want it to go to
Provides a further opportunity for exemption by the addition of Charitable Legacies (which are exempt from IHT)

An Additional Reason is that Nil Rate Band Planning can operate to your best advantage.

NIL Rate Band Planning

If no will is made the whole of your estate is exposed to the full might of Inheritance Tax and follows the rules of intestacy. Where potentially all your inheritors can be subject to an IHT bill.

Making a will or altering an existing will so that a Will Trust is added can save up to £105,200 or 40% of the Nil Rate Band Relief. IHT Planning means that upon the death of the first partner, the estate can take advantage of the threshold exemption from IHT. If a will trust is not in place however, when the first partner dies; the Nil Rate Band Exemption on the first to die estate is not transferable to the second partner that the estate can automatically lose up to £105,200 in tax.

So many couples are unaware or ignore or forget that this is available, But In order to take advantage of this you must remember that each partner should have assets earmarked in their name that are at least equal to, or are in excess of the Nil rate band. Without this the Will Trust route will not work.

Capital Investment Bonds are ideal vehicles for this kind of planning, as they are non income producing assets, but instead have a capital return option of 5% p.a. that can be paid to the remaining partner if required. These are Discretionary Trusts, and the settlor appoints the trustees, and there is a wide range of beneficiaries. If necessary, the capital can by pass the spouse, and be paid to the children or grandchildren if this is required.

Loans from the trust can be made, which are repayable on the death of the beneficiary, and again this can be IHT efficient.

Control of the income and the capital is still in the hands of the Trustees, of whom your partner can be one. You can appoint professional Trustees if you require in the event that you both die together.

Creating a Debt

If no other assets exist outside of the equity residing in the property, another way of reducing the tax burden is to create a debt against the property in the form of equity release.

The capital released from the property can be used to provide a choice of extra capital, additional income or both.

Exemptions & Reliefs

There is a range of exemptions that we can all take advantage of and which mean, for most of us, that our generosity doesn’t create a tax liability.

Gifts between spouses are free of IHT.

Annually: You may each give away £3,000.00. This increases to £6,000.00 if you have not made a gift for last year either. You have to act before the end of the current financial year.

Small Gifts: You may give away as many small gifts as you like, provided the total value doesn’t exceed £250.00.

Gifts on Marriage: Gifts to children or grandchildren on marriage:

Children	£5,000.00
Grandchildren	£2,500.00
Other relatives (or friends)	£1,000.00

Normal Expenditure: Gifts from income after tax has been paid are known as Gifts from Normal Expenditure, as they have no impact on the individual’s normal standard of living.

Gifts to Charities: You can make gifts to registered charities and qualifying political parties and gifts for national or public benefit free from IHT.

Making PETs (Potentially Exempt Transfers)

Lifetime Gifting: A lifetime gift to an individual and to most trusts is a Potentially Exempt Transfer. If the donor survives seven years after making the gift, it will be exempt from IHT If death occurs within seven years of the gift being made; tapering relief may reduce the tax otherwise payable.

The amount of the gift added back in to the estate reduces progressively over the seven years as follows:

Years 1 - 3	100% of the gift
Year 3 - 4	80%
Year 4 - 5	60%
Year 5 - 6	40%
Year 6 - 7	20%

A Word of Caution

When the gift is added back in to the estate it is added in at the bottom of the total value of the estate, and may be covered by the threshold, thus rendering it non-taxable. It is therefore the amount of the tax charged on the gift that is saved, and NOT the gift itself.

PETs and the amount of tax that they represent can be covered by insurance. So if you believe that any gift you may make will create a tax charge by being brought back into your estate within seven years, (subject to the above paragraph) then you can cover the amount of the reducing tax payable on the gift by taking out a special kind of reducing term assurance plan, known as a Gift Inter Vivos.

This will cover the amount of tax on the reducing balance of the gift made over the period.

For a Gift to be effective you have to have given up any possible right to the money, other wise it can fall foul of the "Gift with Reservation" rules. None of the Trusts recommended in today’s presentation are caught by this rule, so you have nothing to fear on this score.

Lifetime Chargeable Gifts

All PETs made within seven years of the date of death are cumulated (added together) to form the total of Lifetime chargeable gifts. All gifts up to the Nil rate threshold are free of IHT. However, if the amount of the total within your lifetime exceeds the threshold, then a tax charge equal to half the full rate is applicable when the chargeable gift is made. In addition, on death within the seven years, the full rate (subject to tapering relief) will be chargeable to the estate in addition. So, for the first five years, the tax liability will be payable in addition to the tax already paid. In years six and seven, the effect of tapering relief means that the lifetime tax paid is likely to be more than the tax payable on death. There is no refund of tax in this event.

Discounted Gift Trust

You receive an "income" from the trust for life but you don’t have any other access to it. In return for this, your inheritance tax liability is reduced and you don’t owe any inheritance tax on any of the trust money after seven years.

In the presentation there is a worked example of a Discounted Gift scheme. The main attractions are:

You can establish a regular income for your remaining lifetime.
You benefit from an immediate Discount on the IHT due on the amount placed in the scheme.
After seven years the entire arrangement is outside the estate for IHT purposes.
If the level of capital falls in the retained part of the fund, the remaining fund can be utilised for income.

The major disadvantage is the fact that you lose access to the capital gifted into the trust to set it up.

We normally recommend that the client attends a medical when effecting these types of contracts, simply to prove that the clients are in reasonably good health when they effect the contract, in the event of death within seven years.

Insuring the Bill

Any remaining liability after you have effected all the possible planning options can be insured against.

This approach accepts the liability exists, and ensures that there is enough money available to meet the bill, or at least make a down payment on the settlement, without having to realise the assets.

Policies can be for a Single Life only, or for a joint life second death plan. These are considerably cheaper than insuring two lives separately. The policies are normally placed in trust, and are for the children’s benefit, or for the person on whom the liability falls.

Flexible Whole of Life policies are normally used as they allow for increases to sums insured if required in the future.

The annual exemption can be a means to cover the cost, as it provides a way of using an exemption to meet the costs of the cover, and provides a simple solution to the problem of who gets what. The estate is preserved, and the normal provisions of the Will can take effect.

These are just some of the options available to you.

For further information or if you wish to make an appointment for a one hour Free of Charge Initial Discussion with Geoff Mason at Dashwoods’ Offices or at your home, please contact:

Geoff Mason from Geoff Mason Associates on 01235 831 273

or e-mail geoff@geoffmasonassociates.co.uk

telephone Daphne at Dashwoods on 01494 521687

or e-mail daphne@dashwoods.co.uk

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