TIPS TO PROTECT YOUR FAMILY WEALTH
HOW TO BEAT INHERITANCE TAX
YOU don’t need to wait for the politicians to make up their minds about whether inheritance tax should be scrapped – you can take action now to protect your family’s wealth from the posthumous grasp of HM Revenue & Customs.
This tax, originally intended for the seriously wealthy, now hits hardest in middle England where many homeowners’ property brings them within its scope – even if they are short of cash or other assets. They cannot give away their homes before they die to bring their net wealth under the inheritance tax (IHT) threshold of £300,000.
As a result increasing numbers are being hit by 40pc tax on everything they own over this amount when they die. Revenues are up by more than 50pc in the past five years as the Government expects to raise £4bn from death duties in this tax year.
The number of homes valued above the IHT threshold has nearly doubled in five years, according to the Halifax, with the average detached house in London, the South East and the South West worth more than £300,000.
Mark Hemingway, from the Halifax, said: “We have always said that IHT should be index-linked in line with increases in house prices. Had IHT kept pace with house prices since 1995, the threshold would now be £490,000 – almost two thirds above its current level. The failure to index-link the threshold is simply forcing more and more people into paying this tax.”
Last week, a Conservative think-tank proposed replacing IHT with capital gains tax, so anything owned for more than 10 years before death would be exempt from tax. However, there is no certainty that a Tory government would enact this proposal and experts warned against the risks of delay.
Julie Hutchison from Standard Life’s estate planning department said: “People should not be under any misapprehension that one’s estate on death would suddenly and automatically become tax-free under these proposals.
“It certainly would not necessarily mean the end of trusts or lifetime gifting. Indeed, it would become imperative to consider lifetime gifting earlier since the current seven-year clock for IHT could effectively become a 10-year clock. And, just as now, assets might not be best handed over directly to younger family members, so the use of trusts could continue to be prudent.”
In the largest poll of Britons aged over 50, Saga found this age group are alarmed about both the IHT bill they will have to pay when they inherit from their parents as well as being concerned about the amount of tax their heirs will pay.
Andrew Goodsell, chief executive of Saga, said: “Today’s baby boomers – those aged over 50 – are all too aware of the doubleedged IHT sword threatening to cut into not only their inheritance, but also that which they leave to their loved ones. So, given that inaction is likely to increase tax bills, Your Money asked a panel of experts what readers can do now to protect their family wealth from IHT.
MAKE A WILL
Without a will, the State decides who receives money and assets in your estate. When this happens in England and Wales, your spouse takes the first £125,000 as well as your personal possessions and an interest for life in half the balance. The rest goes in equal shares to your children.
By making a will you could, for example, transfer some of your assets to children, grandchildren or others after your death within the £300,000 nil-rate band which would mean these bequests were IHT-free. All transfers between spouses are IHT-free but simply passing all assets to the surviving spouse means the IHT allowance of the first spouse to die is wasted and an extra £120,000 extra tax may be paid when the second spouse dies.
You could also use your will to set up a family trust but recent legal changes may mean your will needs updating. It is important to revise your will whenever your circumstances change – for example, when there is an addition to the family.
CHANGE OWNERSHIP OF YOUR HOME
Couples usually own their home jointly, meaning you both own the entire property. You should change ownership to become tenants in common so that you each own half of it.
David Rothenberg of accountants Blick Rothenberg explained: ‘If you own it jointly, the house automatically belongs to the other person when you die.
“By severing the joint tenancy you can give your share away to someone else when you die.”
It is simple and cheap to do. A lawyer should charge around £100 to do it. But it is very important to consider the risk such a bequest might present to the security of tenure of the surviving spouse.
EQUALISE OTHER ASSETS
Equalise your estates. By having most of your cash, savings and assets held jointly or in one name only, the other person will not be able to use up their IHT allowance in their will.
Accountant Charlotte Black of Brewin Dolphin said: “If everything is held jointly it causes a problem as there is nothing to pass on when the first person dies.”
Where husbands and wives or other members of civil partnerships trust each other sufficiently to equalise assets, they may even achieve immediate tax savings through making more use of the personal allowance for income tax – currently £5,225 per person aged under 65 – and capital gains tax – £9,200 per person during the tax year which ends on April 5, 2008.
GIVE WITH WARM HANDS
You can give money and assets away before you die but there are strict limits under the IHT regime. Each person can give away £250 a year to any number of people as well as £3,000 in total annually to different people.
If the £3,000 allowance wasn’t used last year you can give away another £3,000 this year. So, for example, couples who have made no use of this gift allowance can give away £12,000 in total this year.
There are no limits on the amount you can give away regularly out of your income, but it must not reduce your lifestyle.
Mr Rothenberg explained: “The Revenue is getting quite tough on this – so it’s important to keep records of your expenditure as your income has to remain sufficient to cover your expenses. And record what you’ve given away.”
PUT YOUR LIFE COVER IN TRUST
When you die your life insurance will automatically pay out to the beneficiaries without having to go through the IHT regime if it is held in trust. The death benefit passes directly to them without being counted towards your estate. The life company – or, for example, the insurer which issued a with-profits endowment – will give you a form to complete to do this and it is usually free.
CHECK YOUR PENSION ARRANGEMENTS
Employers’ pensions are normally written in trust meaning any death-in-service lump-sum payment passes
directly to whoever you nominate. Pension benefits for a widow or widower do not affect IHT though they will be subject to income tax.
Personal pensions should be written in trust, too, so that the pension pot can pass taxfree to whoever you wish. This must be done before you have to buy an annuity at 75 and cannot be done if you are in poor health – so it makes sense to consider action sooner rather than later. For example, as Mr Rothenberg said: “You can’t change it if you are at death’s door.”
CONSIDER TAX-EFFICIENT INVESTMENTS
Several investments are free of IHT after they have been held for two years. These are shares quoted on the Alternative Investment Market (AIM), forestry land, farming land – provided you farm it, rather than rent it out – and partnerships or shares in a private business.
However, the favourable tax treatment should not blind you to the risks in these investments, particularly AIM shares. Small or recently formed companies are often more vulnerable to setbacks in a particular sector and may have smaller reserves to help them survive difficult conditions. There is no point losing capital to avoid tax. Forestry: P10
THINK OF A PET
Potentially exempt transfers (PETs) are gifts of assets, cash or property you make before you die but you have to survive for seven years before they become IHT-free.
After three years, the beneficiary may get some tax relief which can increase each year until the seven years is up. However, if the gift is less than the nil-rate band the whole amount is added back into your estate when calculating how much you owe in death duties.
Mike Warburton of accountants Grant Thornton explained: “The tax relief is a discount on the tax, not the transfer itself. A single gift of £300,000 six years before the death of the donor will save nothing because the gift would all be within the nil rate band. This is frequently misunderstood.”
You can’t give your house away and continue to live there to diminish IHT liabilities, as the Revenue will regard it as remaining in your estate. But you can give it to a child who lives with you, said John Liddington of lawyers Speechly Bircham. He explained: “The child must live in the property until you die or go in to a home and you must both contribute to the running costs in order not to fall foul of tax rules.”
DISCOUNTED GIFT SCHEMES
These are single premium life policies which pay you an income for life and you give the policy itself away. Because it is paying a fixed income, the value of the policy is reduced. The actual discount is based on your age – the older you are the more valuable it is – so you have to be under 90 years old to use this type of scheme. However, it is important to understand that HM Revenue & Customs has pursued a strategy of challenging tax avoidance schemes in the courts which may continue in future.
SET UP A TRUST IN YOUR WILL
Homeowners usually have the majority of their wealth tied up in their property. Without a trust, you cannot give away your share of the family home safely.
In this instance, the trust only comes into existence when you die. You will your assets and share of your house (held as tenants in common) to the trust up to the value of the nil-rate band, currently £300,000 and due to rise to £350,000 by 2010.
Then the trustees sell the share of the house back to the surviving spouse in return for an IOU. When the second person dies, the loan is repaid, thus using up the first person’s nil-rate band.
It may sound simple but trusts are complicated and need a specialist to handle them. For example, earlier this year, the family of an Oxford don and his wife had to pay £60,000 in IHT when their trusts were considered to fall foul of IHT rules.
The problem was that Dr Patrick Phizackerley gave half his house to his wife, who then willed it to a trust on her death, and the trust lent him the share back until his death. However, the Special Commissioners, who settle disputes between taxpayers and the HM Revenue, ruled the scheme did not apply as Mary Phizackerley had no income and had not contributed to the house.
Mr Liddington said: “Since he’d given her half the house and then loaned it back to him via the trust after her death, he was considered to have lent his gift back to himself so the loan was not deductible for IHT.”