Your biggest-ever bill could arrive when you die, because Inheritance Tax at 40% could devastate your estate.
According to research from bank Bradford & Bingley, only one in fifty people (2%) who think that they will be liable to pay Inheritance Tax (IHT) have planned ahead by taking steps to reduce its impact. What's more, almost half of adults don't know the current rate of IHT, and more than a quarter wrongly assume that they can settle any IHT bill from their inheritance.
A decade of rising house prices has pushed millions of individuals into the IHT bracket -- even a modest home could gobble up the £285,000 nil-rate band for the 2006/07 tax year, with the remaining estate liable to Inheritance Tax at 40%. So, even if you've never paid higher-rate tax in your life, you could hand over two-fifths of everything you own over the nil-rate band when you die!
Alas, far too many of us underestimate our total wealth (including property, savings and investments, cars, jewellery, furnishings and all other possessions), leaving us at risk of a whopping great tax bill on death. Thus, if you'd prefer to leave your estate to your children or other relatives, rather than the taxman, read these ten tips, courtesy of accounting, business and tax advisory group Vantis:
1) Use your nil-rate band and trusts
Although the Treasury has cracked down on the use of certain trusts set up to mitigate IHT bills, it's still possible to avoid IHT by making a gift this tax year of less than £285,000 to most types of trust. This step alone could save you £114,000, so you can still trust trusts!
2) Make the most of business property relief
Certain assets qualify for 100% 'business property relief', including shares in unquoted trading companies which have been held for at least two years. These assets can be gifted from a donor's estate without triggering an immediate IHT liability. Although the value of, say, qualifying AIM-listed shares (or a family trading company) currently avoids IHT (subject to certain conditions), it may not in the future if business property relief is either reduced or abolished.
3) Make potentially exempt transfers (PETs)
If you make an outright gift to individuals or 'disabled' trusts, do not retain a direct or indirect benefit in the assets being gifted, and survive for seven years, the value of the gift falls outside of your estate for IHT purposes. Furthermore, if you die after at least three years, taper relief will reduce your IHT bill.
4) Use your annual exemptions
In each tax year, you can gift up to the annual exemption of £3,000 to a person or trust of your choice. In addition, any unused exemption from the previous tax year can be carried forward to the current tax year, but no further. Hence, a husband and wife could gift assets worth £12,000 in the 2006/07 tax year if they each have the previous year's exemptions available. Over twenty years, this £3,000-a-year allowance adds up to an IHT saving of 40% of £60,000, or £24,000 per person.
5) Make small gifts
In each tax year, you can gift up to £250 to any number of people, completely free of IHT. So, a pair of grandparents could give each of their eight grandchildren £250 a year, a total of £4,000 a year. Over twenty years, this adds up to an IHT saving of 40% of £80,000, or £32,000.
6) Make marriage gifts
A parent can gift £5,000 to a child on the occasion of their marriage; a grandparent can gift £2,500; other persons can gift £1,000 -- all free of IHT.
7) Gifts out of income
You can make regular IHT-free gifts out of income, but you must show that these gifts are habitual (though not necessarily annual), are made from post-tax income, and leave you with enough income to maintain your standard of living. This is a significant concession which is widely under-used, especially by higher earners.
8) Use the spouse exemption
Married couples and same-sex couples who have undergone a Civil Partnership should take advantage of the exemption for transfers between spouses, either during their lifetime or on death. Spousal transfers can be used to equalise assets within a couple, in order to ensure that both partners have enough assets in their estates to meet the nil-rate band legacy trust which is a standard feature of most Wills. This exemption is capped at £55,000 for a transfer from a UK-domiciled spouse to a foreign-domiciled spouse.
9) Make charitable donations
One way to keep the greedy taxman's hands off your estate is to make IHT-exempt gifts to charities, either during your lifetime or via your Will. Gifts to political parties, gifts for national purposes and transfers to employee trusts will also qualify, subject to certain conditions being met. Indeed, some generous folk with no surviving dependants leave their entire estate to good causes, rather than the Treasury!
10) And finally: make a Will
Some of the above advice relies on making a Will. What's more, without a well-drafted Will, your estate is at the mercy of the somewhat cumbersome intestacy laws, which is a complete no-no. Hence, my advice is to consult a professional will-drafter, such as a member of the Society of Trust and Estate Practitioners. You can search for STEP members in your local area here.
Finally, don't put IHT planning at the bottom of your to-do list. The Treasury has already made radical changes to the treatment of trusts, so it could go on to undermine the above IHT-avoidance schemes. Any delay could cost you dearly in the long run, so take professional advice and get on with it!
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