Inheritance Tax (IHT) is becoming a prospect for an ever increasing proportion of the population, compounded by the Nil Rate Band (NRB) stagnating – it has been £325,000 since 2009 and will not rise for at least another two years. For those with higher value estates, the introduction of the Residential Nil Rate Band (NRB) assists, but many still have a cause to consider mitigating their IHT liability.
There are a number actions that can be taken, from utilising gift exemptions, such as the annual £3,000 exemption, to placing property on trust in the hope that you will survive the action by seven years, with the result being that the property falls out of your estate.
With property prices having risen dramatically over the past decade, many people have estates that are in excess of the NRB available with the majority of that value being in their house. A number of firms market miracle cures in the form of plans to put the house into trust in order to avoid IHT, sometimes throwing up negative consequences in the process. In order for a Trust to be properly established, the Settlor (the person who puts their property on to trust) must divest themselves of the property in favour of the Trustees (the people who will operate the Trust). In order to be effective, the Settlor must not benefit from the Trust. For this reason, the Settlor would need to rent the property from the Trust in a genuine commercial arrangement. This may be a helpful way of increasing the amount leaving your estate for the benefit of the Trust, provided you can afford it. Having spent a long time paying down a mortgage, this may not be so desirable with a reduced pension income, for example.
So, whilst an Inheritance Tax saving may be achieved, at what cost? There may be an Income Tax charge on the rents that, cumulatively, exceeds the IHT saving. It may not even be a financial cost – it could be the inconvenience of needing the Trustees approval for capital works. Perhaps the biggest negative is the loss of control over your future accommodation, should the trustees sell the property or should you wish to move. Unless the Trust can justify purchasing a new house for you to rent, in line with their general investment responsibilities as Trustees, you may not have the capital available to fund a purchase. The duty of the Trustees must be to the Beneficiaries, not the Settlor or any other party.
It is important to remember that Inheritance Tax will be charged on the value of your estate on your death, not in your lifetime. The saving that you may make will benefit the next generation but not you. Would your children wish you to sacrifice your security and enjoyment for the sake of a higher inheritance?
This is not to say that Trusts are not an effective tool in this situation for many people, but not for all. It is of course important is having an advisor who understands Inheritance Tax but this alone falls short. The real value comes from an advisor who takes the time to understand your aims and your circumstances. This way, they can ensure that any IHT planning suits your needs, both current and future.