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| Inheritance tax planning | |
| When you die, your dependants and beneficiaries pay inheritance tax (IHT) at a rate of 40% of the value of your estate to HM Revenue and Customs. The government provides a tax-free allowance to each individual. In the 2006-07 tax year, this allowance (known as the nil rate band) was £285,000. Your estate faces IHT on wealth valued above this nil rate band.
The tax has to be paid before property and assets can be passed on to beneficiaries. You can apply for the instalment option where an estate has property, land or private company shares. Under this arrangement, you pay one-tenth of the IHT bill for the grant of probate to be completed. The rest of the IHT bill can be paid when the assets are sold.
IHT has traditionally only affected a small number of estates. Increases in the nil rate band, however, have not kept pace with rises in house prices. If the nil rate band had risen in line with house prices over the past 10 years then it would now be £430,000 rather than £285,000. This is widening the IHT net considerably.
For example, the amount of IHT paid to HMRC rose 13% in the first half of 2006 to hit a record £1.7 billion. In the 2005-06 tax year, HMRC received £3.3 billion in IHT and expected this to rise to £3.6 billion in the 2006-07 tax year. It is estimated by Halifax that by 2020 the government will collect £5.5 billion in IHT a year.
Studies have also revealed there are now 1.5 million properties valued at more than the 2006-07 IHT nil rate band of £285,000. This is 8% of all owner-occupied properties. If the nil rate band rises in line with inflation, Halifax believes this number could grow to 4.2 million by 2020.
Naturally, there is keen interest to mitigate IHT. You can make potentially exempt transfers (PET) for any value. If you then live for another seven years, the PET is exempt from IHT. A core part of IHT planning could be to use as many of these PETs as possible during your lifetime.
Not everyone can afford to give away sizeable amounts of money during their lifetime, however. Gift with reservation tax rules aim to prevent you giving away wealth and then continue to benefit from the assets you have given away.
There are a number of other reliefs available for you to mitigate IHT.
· Inter-spouse transfers. You can leave the whole of your estate to your spouse and it will be free of tax. This is an attractive option but it leaves a potentially large tax bill for beneficiaries when your spouse dies.
· You can make annual gifts of up to £3,000 or £6,000 if you are a married couple. There are also allowances for wedding gifts to be exempt from IHT. Any number of small gifts of up to £250 can be made.
· Other gifts free of IHT include those to charities.
An often over-looked planning measure that is gaining prominence is the “gift from income” rules. You can make regular income payments that are free from IHT. There is no maximum limit on these payments but you need to show it comes from income that is surplus to what is required to fund your lifestyle. The payments need to be regular, although this can be as infrequently as once a year.
HMRC does not ask for paperwork to show you comply with the gift from income rules during your lifetime. Keeping records during your lifetime, however, should ease the process of gaining the IHT exemption from your estate and speed up probate. A written statement of your intention of making these regular gifts from income is advisable.
After your death, the executors of your estate will provide details of your income, taxes paid and living costs for each year you made a gift from income. This is used to evaluate the amount of assets that can be counted as gifts from income as opposed to gifts from capital.
A problem with this planning is that it is not known if the income is exempt from IHT until you die. HMRC says it is more likely to qualify if income payments have been made for at least three years.
This planning is most appropriate if you receive very large income, dividends or bonuses even if this is only for a short period of time. Examples include City workers receiving year-end bonuses, sportsmen and women, hedge fund and private equity managers.
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