Tax and your investments

Inheritance tax (IHT) has some unique features. It is easy to collect because the authorities meet with least resistance but, conversely, it is relatively easy for wealthy taxpayers to at least minimise it, if not avoid it altogether, and consequently IHT is sometimes referred to as a voluntary tax.

Nonetheless planning to minimise IHT is something that many put off until it is too late and early attention to this tax is almost always worthwhile.

Currently the threshold for IHT is £285,000 (this is sometimes called the nil rate band) and even if your assets are worth less than this you should consider making a Will so that you choose who gets your assets after your death.

The current regime

The key points of the current regime are as follows:

• IHT is charged on a person’s estate when they die and on certain gifts made during their lifetime
• the rate of tax on death is 40% and 20% on lifetime chargeable transfers. The first £285,000 is not chargeable
• some lifetime gifts are treated as ‘potentially exempt transfers’ or PETs. So long as the donor lives for at least seven years after making the PET there will be no possibility of an IHT charge whatever the size of the gift
• there are numerous exemptions and reliefs.

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So what’s the problem?

IHT is still a problem because:

• many are simply not in a position to make substantial lifetime gifts because it will leave them with insufficient capital to live on. As a consequence there is likely to be significant value retained in estates on death
• at the time of writing the threshold for IHT, £285,000, is roughly the same as the average price of a detached house in England and Wales. In such a case the house alone will use up the nil rate band and any remaining assets, such as investments and cash reserves, will be charged to IHT at 40%.

It is important therefore to consider ways of reducing any potential IHT liability.

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Mitigating the liability

Don’t waste your exemptions

Regularly using IHT exemptions will build up funds outside of the estate without incurring an IHT liability. A husband and wife can each take advantage of the exemptions, the main ones being:

• an annual allowance of £3,000 per donor per year. It can be carried forward for one year only if unused
• small gifts not exceeding £250 in total per donee per tax year
• gifts made out of income that are typical and habitual
• gifts made in consideration of marriage up to £5,000 if made by a parent, £2,500 by grandparents and £1,000 by others
• gifts to charities whether made during lifetime or on death
• gifts between spouses and same sex couples in a civil partnership, whether made during lifetime or on death.
  

Use the nil rate band
In lifetime

On death

On death, assuming the nil rate band has not already been utilised in the last seven years, it pays to ensure that it is not wasted.

Example:

Tom dies leaving the whole of his estate of £800,000 to his wife Pru. A few years later Pru dies leaving her whole estate of £900,000 to her children.

On Tom’s death there is no IHT, as transfers between husband and wife are exempt, but on Pru’s death the IHT payable is on £900,000 less any available nil rate band.

Had Tom instead left £285,000 to his children and £515,000 to Pru then on Tom’s death there is still no IHT. On Pru’s death, her estate will now be worth £615,000 and IHT will be payable on this less the available nil rate band. At current rates this saves £114,000 (40% @ £285,000).

Discretionary Will trust

Couples with modest estates find it hard to leave the nil rate band to children in their Will since that may leave the surviving partner short of funds. This can be overcome by the use of Discretionary Will trusts.

Use the reliefs

When business or agricultural property is transferred there is a percentage reduction in the value of the transfer. Often this provides 100% relief. In cases where full relief is available there is little incentive, from a tax point of view, to make lifetime transfers of such assets. Additionally, no CGT will be payable where the asset is included in the estate on death.

Leaving business assets to the spouse will waste the relief since transfers to a spouse are exempt anyway. Therefore consider using business or agricultural property to make gifts to the children or others.

Make a Will

If you die without a Will, the intestacy provisions will apply and may result in your estate being distributed in a way you would not have chosen.

Use life assurance

Life assurance arrangements can be used as a means of removing value from an estate and also as a method of funding IHT liabilities. A policy can be arranged to cover IHT due on death. It is particularly useful in providing funds to meet an IHT liability where the assets are not easily realised, eg family company shares.