The impact of inheritance tax
For many people, inheritance tax is the largest amount they will effectively pay to the Exchequer during their whole life. As things stand, there is a flat rate of inheritance tax of 40% charged on the excess over the current nil rate band. This was set at £312,000 from April 2008.
The estate for this purpose includes all the assets held at death, assets held in certain trusts and crucially the value of gifts made in the seven years prior to death. As former Labour Chancellor, Dennis Healey, once observed: "to save inheritance tax you just need to have a good adviser and know how long you are likely to live!"
If you want to save inheritance tax then advance planning is essential and this has to take into account the present and likely future value of your assets, your individual family circumstances and, most importantly, the future security of you and your spouse or civil partner.
Inheritance tax – the transferable nil rate band
Following the proposal in 2007 by George Osborne, the Shadow Chancellor, to increase the nil rate band to £1m if the Conservatives win the next election, the Government introduced the so-called transferable nil rate band.
It used to be the case that in order for a husband and wife or civil partners to utilise both nil rate bands, it was necessary on the first death for a legacy of at least that amount to be left to other members of the family or into a discretionary trust.
This is no longer necessary and if all assets are left to the survivor then on the second death two nil rate bands can be deducted for inheritance tax purposes. Does this mean that legacies to children and grandchildren or into discretionary trusts are no longer necessary? In some cases this will be the answer but in many cases it may still be preferable if at least some of the assets are left to other members of the family or into a trust from which the surviving spouse or civil partner can still benefit.
It may be, for example, that you have valuable assets which are expected to increase significantly in value over the coming years at a rate which will exceed likely increases in the nil rate band. On the other hand, you may wish to use trust structures to protect assets and preserve them for future generations.
No two cases are the same and the question to ask in every case is: "Under our current will arrangements where will our assets go and at what cost in taxation terms?" If you don't know the answer, or maybe you don't like the answer, then I am sure we can help. Couples who are not married or in a civil partnership cannot benefit from the transferable nil rate band and they should certainly still consider the use of nil rate band trusts in their wills and the possibility of lifetime gifts.
Tax effective gifts
The simple way to avoid inheritance tax is to give away your assets and live for seven years! If you can afford to make such gifts and wish to do so, then it is important that those gifts are made without any reservation of benefit, i.e. with no strings attached.
The revenue have complicated rules to ensure that you cannot benefit from such gifts and even where these rules cannot apply for inheritance tax purposes they can then impose income tax charges under the so-called "pre-owned assets" legislation.
In a simple example of its effect, the revenue could charge you an effective rent for living in a property that you gave away and then subsequently moved into.
There are ways to prevent these rules applying so that gifts are tax effective and we can advise on these.
Not everyone wants to give their assets away and there are two main objections.
Firstly the need to ensure your own future security and secondly the wish to protect potential recipients of your wealth from themselves and others.
To assess your own security you may need financial planning advice and we can assist in discussions with your advisors or in selecting advisors.
To protect potential beneficiaries we can advise on the use of trust or business structures which leave you with a measure of control and/or delay access to any funds you transfer out of your estate.
Gifts out of income
Inheritance tax is charged on the estate at death plus gifts made in the seven years prior to death.
There is however an important exception for gifts made in this seven year period if it can be shown they are "regular gifts out of income".
There are detailed rules to be satisfied but in general terms it is necessary to demonstrate a commitment to regular gifts and to show that these have been made out of surplus income rather than capital.
A typical use of this exception is the regular payment of school fees but any financial support for your family could potentially qualify. The important point is to ensure the conditions are met and the payments properly documented. If you require further information or help please let us know.
The use of trusts in tax planning
The Finance Act 2006 introduced major reforms to the taxation of trusts. The changes have little effect for trusts that are created under a will and, for example, a common use of such a trust is to hold assets so that the surviving spouse can have access to them but the trust provides for the remaining assets to pass to the children of the marriage in due course.
For lifetime trusts, however, there is now a limit which can be introduced into such a trust without incurring a flat rate charge of 20%. The 20% tax charge applies if the amount placed into trust by an individual, plus any other chargeable transfers he or she has made in the previous seven years, exceeds the current nil rate band. The nil rate band is £312,000 at present and so this means that a couple who have made no previous lifetime chargeable transfers can put a total of £624,000 into trust at this time but then in seven years' time will be able to transfer further amounts equivalent to the nil rate bands at that time.
A very important point, however, is that whilst there is a general limit on the transfer into lifetime trusts, this does not apply to property which qualifies for 100% business property relief or agricultural property relief. If, therefore, you own shares in a qualifying family company then any amount can be transferred into a lifetime trust without incurring a charge to IHT.
If you hold shares in a family company and intend to retain them until you die, then there is an argument to say that, provided the business property relief is not abolished in the meantime, the shares may as well be retained, particularly as they are re-valued at death for capital gains tax purposes. If however it is likely that the shares will be sold, so that the cash proceeds will then be liable to the full IHT charge of 40% on death, a transfer into trust prior to the sale should be considered.
It used to be the case that a transfer into trust prior to sale was not advised because it jeopardised the availability of Capital Gains Tax taper relief. However, the abolition of this relief means that a transfer into trust can now take place within a few days of the sale. The mistake many clients make is to deal with the sale first and then come along to talk about their inheritance tax planning, and by then of course it is too late to take advantage of this valuable relief.
Business and agricultural property
There are generous Inheritance Tax exemptions for certain business property and for the agricultural value of certain farming land. These reliefs can either be used to pass assets onto the next generation in a tax efficient manner or to set up flexible trust structures prior to the sale of a business so that significant sums can be held outside your estate and yet not be at the absolute disposal of your children and/or grandchildren.
Trusts are still very important in Capital Tax planning and this is particularly the case where business or agricultural properties are involved. The previous section on the use of trusts in tax planning explains why a transfer into trust prior to sale of a business should be considered.
If it is likely a business will be sold after the first spouse dies, then it is possible for the proceeds, irrespective of amount, to be held in a trust from which the surviving spouse can benefit for the remainder of his or her life without those proceeds ever being subjected to inheritance tax.
Do you have a will?
You may not know but dying without a will can have very expensive and upsetting consequences for surviving family members. The first thing to note is that if you have any children your surviving spouse will only benefit from a statutory legacy of £250,000 and a trust interest in half of the remaining estate.
Further, your children will be entitled to the other half of the residue of the estate outright at the age of 18. You cannot delay their inheritance of potentially significant assets until they are mature enough to deal with them.
You also lose the opportunity to choose executors to deal with the administration of your estate. Instead administrators are appointed from a pre-set statutory list. This can be particularly difficult if you have a second spouse and children of a first marriage, as they can be required to act together as the administrators of the estate.
If you have an interest in a private company or partnership there are significant inheritance tax savings that can be made through the use of an appropriate tax planning will. By not having a will in place your surviving family will miss out on the opportunity of benefitting from these significant inheritance tax savings.
In short, it is much better to die with a will in place, even if it is a simple one that can be varied if necessary, than to die without a will at all.
Lasting powers of attorney
If you would like the option of someone else looking after your affairs at some time in the future, perhaps because of infirmity or mental incapacity, you may wish to consider a Lasting Power of Attorney ("LPA").
There are two types of LPA, one dealing with financial matters and one for personal welfare matters.
LPAs are administered by the Court of Protection and the Office of the Public Guardian and have replaced the old style Enduring Powers of Attorney (but if you have an existing Enduring Power of Attorney it remains valid). They are designed to provide more protection for those entering into them but this has necessarily led to a more complex system which requires more time to implement.
If you are concerned about future incapacity it is advisable to consider the options sooner rather than later so that the necessary forms can be completed and registered with the Court in good time.
In these difficult times it is more important than ever to plan your finances so that your wealth is properly managed and preserved. This is particularly important if you are considering lifetime gifts of capital since you need to be sure you retain sufficient wealth for the future security of you and your family.
Financial planning advice is provided by a wide array of sources including banks, independent financial advisers and traditional stock broking firms. The choice of adviser can be difficult because they each have a different perspective and approach.