Money
Retirement
Taming Inheritance Tax - part three
IHT case study: John has an estate worth £385,000. He decides to give £100,000 to a charity which rescues donkeys. That brings his estate down to £285,000 so no Inheritance Tax is due and his three children get £95,000 each. Had he not made the gift, the estate would have been £385,000 and after paying £40,000 tax the children would have had £115,000, an extra £20,000, each.
All these allowances are personal. So two parents can each give £3,000 a year and if they gave away nothing last year, they can give £12,000 this year between them without it counting as part of their estate. If they are married or civil partners it doesn't even matter if only one of them has the money - one can give the money to the other with no tax consequences who can then make the exempt gift.
If you want to make gifts using these exemptions it is important that you keep a record of what you are doing and why. For example if you are giving away income you do not need, write a statement of your intentions and keep it with your papers.
All these amounts are completely exempt from IHT however long you live. And remember that if you live for seven years after making any gift then that is also completely exempt.
One final point on gifts. Never give away money that you need. It is your money, not your heirs'. You worked hard for it and you should benefit from it during your own life.
Equity release
Some advisers will suggest you take out what is called an 'equity release' plan to reduce your liability to Inheritance Tax. It works like this. You borrow money against the value of your home. While you are alive you pay no interest on the loan. When you die the loan and all the accrued interest is paid off from the value of your home. The value of your home is therefore less and the Inheritance Tax is reduced. However, you should never embark on equity release just to reduce IHT. Equity release might be a perfectly sensible way of raising money if you need more income or capital in retirement. And of course taking out an equity release product will reduce the amount of your estate and the tax due. But that is a side effect. If you do not need extra capital or income then equity release should never be considered. Again, it is better for your heirs to have 60 per cent of something than 100 per cent of nothing.
Life Insurance
If you have a life insurance policy that pays out on your death the money will normally form part of your estate. The same is true of a death-in-service benefit or insurance paid as part of a pension or part of some sorts of mortgage. However you can usually avoid IHT being due by making the policy what is called 'written in trust'. Instead of going directly to your dependants the money is paid into a trust which then passes it on to your dependants. That two step process avoids the proceeds counting as part of your estate. However, this arrangement is now more difficult following recent changes in trust law.
In the past the proceeds would be paid into what is called a 'discretionary trust' where the trustees decide who to pay the money to and when. They will be professionals with the insurance company and will follow your request set out in what is called a 'letter of wishes'. If such a discretionary trust was written before 22 March 2006 then the arrangement works and no tax is due. But if it was written to a discretionary trust after that date and the value of the policy is more than £285,000 then a tax charge of 20% of the excess will be made when the policy is made over to the trust. If the trustees do not pass over the money to the heirs at once then every ten years another charge of around 6% on the excess over the nil rate band will be due.
An alternative is to write it into what is called a 'bare trust'. With a bare trust the trustees make no decisions - the policy belongs to the people named in the trust who would normally be your heirs. Bare trusts are not subject to any special tax regime - the money is taxed as it arises as belonging to the recipient. There would normally not be any tax due on the premiums you pay or the pay out on your death.
Ask your insurance company if your policy has been written in trust; if it has not, ask how you can do so and make sure it is a bare trust not a discretionary trust if the value is likely to be more than £285,000. Some insurance companies may make a charge or be less than helpful.
If you have considerable assets and want to give money away in the hopes you will live seven years, you can take out a specific life insurance policy to pay the IHT on it if you do not. The policy should be a pure life insurance policy with no investment element and, of course, the proceeds should be written into a bare trust. Such policies can be very cheap for people in their fifties but of course the older you get the more expensive they become.
Couples
Husbands and wives do not have to pay any Inheritance Tax on money or property left to them by their spouse. But that does not mean couples need not worry about Inheritance Tax until the first person has passed away. Quite the opposite. Because when the second spouse dies tax is due on the whole estate. So the exemption defers the tax but does not avoid it. Couples who leave all their property to each other are wasting their own threshold of £285,000.
Couples can save their heirs tens of thousands of pounds in Inheritance Tax if they take some simple steps while they are both alive. All they have to do is split their property and in effect double the amount they can leave without paying tax to well over half a million pounds.
