How do I reduce my inheritance tax liability?
Inheritance Tax (IHT) is a tax at 40% and is fast becoming onerous on most UK families, even those with modest wealth. The rise in property values has pushed many people's estate value over the Inheritance Tax threshold of £325,000 (2010-2011 tax year). This is, potentially, bad news for the 1.4 million UK homeowners who now fall within the clutches of this tax.
Without proper tax planning, many people can end up leaving a huge tax liability on their death, considerably reducing the value of the estate passing to their beneficiaries.
To ensure that your family benefits and not the government it pays to plan ahead. So what are our tips?
1. Make a plan
First, work out if inheritance tax will be an issue by adding up the value of your savings, investments, property and personal possessions. Do not forget Individual savings accounts (ISAs) - though they are tax-free during your lifetime - they form part of your estate for IHT. Finally, then take off the value of any debts. If the total adds up to more than £650,000 for a married couple or £325,000 for an individual then IHT will apply.
2. Write a will
A will makes your wishes concrete and clarifies who should get what. It will stop any assets being divided under the rules of intestacy, where even spouses are not guaranteed to inherit everything. It can also be the first step to reducing an inheritance tax bill.
Many married couples can draft wills that pay part of their wealth into a trust on death. The surviving spouse can benefit from the legacy, but so can others such as children and grandchildren.
3. Reduce the value of your estate
You cannot be taxed on money that was never yours. So ensure that as much as possible is outside your estate. Write any new life insurance plans under trust.
Many existing life policies can be transferred into a trust. If your employer pays a death benefit, complete a nomination form to make sure any money goes directly to the person you choose and not into your estate. You can even nominate a separate Trust to receive the proceeds.
It is also worth thinking about legacies you might receive. Someone who benefits from a legacy can divert that legacy to another person. You can apply for a 'deed of variation' within two years of the death of the giver.
4. Go and get married!
Anything you pass on to a spouse is free of inheritance tax. The same concession applies to same-sex couples who register under civil partnership laws.
However, legacies between unmarried couples are not tax free.
5. What about your home?
For many families, their homes are their biggest asset - and their biggest inheritance tax headache. The Government has clamped down on schemes to get around the 'gifts with reservation' rules. These allowed people to give away homes, but still live in them.
But there are still ways to reduce IHT. Consider equity release or downsizing? Also,most couples who own a home together are joint tenants. This means that if one person dies, the other automatically becomes the outright owner of the property. The alternative is to register as 'tenants in common', each owning half the property absolutely. This means that on death, your share may be left to someone else or to a trust to keep down the size of your estate.
6. Invest in IHT exempt assets
Some investments are given favourable treatment for IHT purposes, including shares in unquoted businesses, woodlands, farms and farmland. Many shares on the Alternative Investment Market (AIM) stock market also qualify for relief. So on death, the assets can pass across free of inheritance tax.
7. Use a trust
Aside from will trusts, several other trusts can help in estate planning. Depending on the type you choose, it can still be possible to enjoy an income from money paid into trust, even though you are no longer the legal owner of that money.
Specialist advice is essential for anyone considering setting up trusts.
8. Use Insurance
Another option is to estimate how big an IHT bill your heirs face then arrange insurance to cover part or all of it. Whole-of-life insurance written under trust can provide a lump sum on death that is outside an estate.
On death, the proceeds of the policy can be used to settle the tax bill. The premiums are treated for tax purposes as a gift from regular income. Think of this as building a fund to pay your tax. The advantage is that you retain your wealth through your lifetime and so have the funds if, for example, you need to go into long-term care.
9. Spend it
Do not lose sight of whose money it is in the first place. If you are worried your wealth is simply building up a tax bill, then spend it! But remember, if you do decide to spend it, you need to make sure that whatever you buy is worth nothing once you've enjoyed it, for example holidays. Otherwise, it will still form part of your estate and be liable to IHT
10. Use annual allowances
Giving away money will reduce your estate, but will not cut the tax liability immediately. You have to survive for seven years for most gifts to escape the IHT net. However, within that last seven years, the Revenue allows gifts of up to £3,000 each tax year. Unlimited gifts up to £250 a person per tax year are exempt, as are payments up to £5,000 for wedding gifts.
The most powerful concession is that regular gifts made from normal income can be exempt from IHT. You must show you have been giving regularly and are not materially reducing your standard of living or running down savings.
This concession allows parents or grandparents to help children without fear of inheritance tax problems down the line. However, HM Revenue & Customs will demand details of these gifts when the giver dies.
Clearly, these tips should only be used as a guide and there is no substitute for seeking professional advice.