Planning to Minimise Inheritance Tax Liability

 

 

 [a] Lifetime Planning

 

Inheritance Tax [IHT] is a tax on capital.   It is principally levied on an individual’s Estate at death, on lifetime transfers made into ‘relevant property’ Trusts (as defined within Finance Bill 2006), and on other lifetime transfers made within the seven years preceding death. It is therefore possible to make considerable savings in potential IHT liability on death, through judicious lifetime planning to reduce the ultimate value of Estate at death, by making Gifts.   Cautionary Notes : [1] A gift of an asset (other than cash) may also give rise to Capital Gains Tax liability, although CGT exemptions may apply.  [2] Also, while one of the cornerstones of Inheritance Tax Planning is to make lifetime gifts, this must be considered very carefully against the donor’s continuing income requirements.   As the ultimate planning vehicle, Insurance can be taken out to cover any residual IHT liability arising on death.

 

[1] Gifts using available Exemptions

Spouse Exemption

Transfers between spouses are exempt for IHT purposes, both on lifetime gifts and Estate passing on death.

Donor’s Annual Exemption

The first £3,000 of transfers in any fiscal year are exempt from IHT.   If all, or any part of the £3,000 exemption is not used in a year, it may be carried forward for one year only.

Small Gifts

Gifts of up to £250 by way of outright gift to any one person in any one fiscal year are exempt  - there is no limit to the number of persons to whom these gifts may be given.

Normal Expenditure out of Income

A gift is exempt to the extent that it forms part of the normal or habitual expenditure of the transferor, is made out of income, and the normal standard of living of the transferor is not adversely affected.

Gifts in Consideration of Marriage

Gifts in consideration of marriage are exempt within certain limits.   Where the transferor is a parent of either party to the marriage, the first £5,000 transferred by that parent is exempt from IHT.   A grandparent may gift up to a limit of £2,500 exempt.

Gifts to Charities

A transfer of value made to a Charity is exempt from IHT whether made on the death of the transferor, or during life.

 

[2] Gifts which are Potentially Exempt Transfers [PETs]

Generally, gifts of unlimited amounts by an individual to another individual [so far as not covered by the above exemptions] are EXEMPT, provided the donor survives for a period of seven years from the date of the gift.  If the donor fails to survive seven years, the PET becomes a chargeable transfer, but the IHT will be reduced by taper relief at specified rates depending on the number of years between gift and death.

 

[3] Gifts using available Business and Agricultural Property Reliefs

In certain circumstances, relief of 100% reduction in value of qualifying business assets or agricultural property may be due, giving a NIL chargeable transfer of value.   In other circumstances, relief of 50% reduction in value may be due.

 

 

 

 

 [b] Post Death Planning

 

On the death of any person, IHT is chargeable on the value of his/her Estate as valued immediately before his/her death.   The current rates of IHT, as from 6th April 2008 are first £312,000 @ NIL (nil-rate band); over £312,000 @ 40%.  (From 6th April 2006 to 5th April 2007 £285,000 nil-rate band; from 6th April 2007 to 5th April 2008 £300,000 nil-rate band.) When you consider the value of your family home, you can appreciate the ease with which the level of liability can be reached.

 

 

Post Death Adjustments

When someone dies, there may be a number of reasons why the beneficiaries of the deceased’s Estate wish to alter the destination of the assets.

 

 

The main reasons for this are as follows:-

 

To reduce the burden of IHT, in particular to ensure full use of the nil-rate IHT band

 

To pass inheritance to next generation where the immediate beneficiaries are already wealthy, i.e. by-passing a generation chargeable to IHT

 

To Claim or Disclaim Legal Rights to adjust ‘inadequate’ provision in a Will

 

The Estate does not pass to the overall desired destination under Intestacy Rules

 

 

These changes are legally effected by:

 

Spouse / Children claiming / disclaiming Legal Rights

 

Executing a Deed of Variation / Deed of Family Arrangement

 

 

 

Example of the use of a Deed of Variation / Deed of Family Arrangement

to utilise the NIL-Rate Band

 

 

Husband’s Estate   £400,000                 Wife’s Estate    £350,000

 

Their respective Wills leave everything to the surviving spouse. Thereafter to their daughter.

 

Thus, if the husband dies first, the residue passing to the widow is exempt.  No IHT due by his Executors, because of Spouse Exemption.

 

 

Husband’s Estate:-

            Estate                                                   £400,000

            Spouse Exemption                                 (£400,000)

            Chargeable to IHT                                           £NIL

 

On the Widow’s subsequent death, her Estate then becomes:-

            Own Estate                                           £350,000

            From husband                                       £400,000 

Total Estate                                           £750,000

           

IHT on her death (assuming no changes in Value of Estate or IHT rates):-

            £312,000 @ NIL                                £NIL

            £438,000 @ 40%                                   £175,200

            Total IHT                                               £175,200

 

This leaves the daughter with a net inheritance as follows:-

            Estate on Mother’s death                     £750,000

            Less IHT payable                                 (£175,200)

            Net Residue Received                         £574,800

 

If a Deed of Variation were effected on the husband’s death to leave a Legacy of £312,000 to the daughter, (i.e. making full use of the nil-rate Band on the husband’s death instead of using Spouse Exemption), with Residue to widow £88,000, the IHT payable on the husband’s death is:-

 

Husband’s Estate:-

            Estate                                                   £400,000

            Spouse Exemption                                   (£88,000)

            Chargeable to IHT                                   £312,000

            £312,000 @ NIL                                              £NIL

            Total IHT                                                       £NIL

 

On the Widow’s subsequent death, her Estate then becomes:-

            Own Estate                                           £350,000

            From husband

(£400,000 – Legacy to daughter £312,000)                                                                                                                                                 £88,000

Total Estate                                           £438,000

 

IHT on her death (assuming no changes in Value of Estate or IHT rates):-

            £312,000 @ NIL                                 £NIL

            £126,000 @ 40%                                     £50,400

            Total IHT                                                 £50,400

 

This would leave the daughter with a net inheritance as follows:-

            Legacy from Father                             £312,000

            Inheritance from Mother

(£438,000 less IHT £50,400)                   £387,600

Total Inheritances                                £699,600

 

This would give the daughter an additional £124,800 (£699,600 - £574,800), being equal to £312,000 @ 40% = £124,800 IHT saved.

 

 

Cautionary Note : Care should always be exercised to ensure that the living standards of a surviving spouse are not jeopardised by passing too substantial a part of the deceased’s Estate to children at the expense of the surviving spouse.

 

 

[c] Effects of Draft Legislation contained in the Finance Bill 2008

 

Transfer of unused Inheritance Tax NIL-Rate Band between spouses and civil partners where the survivor dies on or after 9th October 2007

 

Explanatory Note : The possibility of transferring any unused IHT nil-rate band on a person’s death to the Estate of their surviving spouse or civil partner (as explained fully below), will provide the opportunity, in some cases, to relax the need to consider Inheritance Tax Planning by means of Post Death Adjustments on the first death.  This more relaxed approach will probably be most suitable in instances where the main reason for such planning is simply to ensure that full Inheritance Tax benefit is taken of the nil-rate band available from the Estate of the first spouse or civil partner, by transfer to the Estate on the second death. 

 

However, Post Death Adjustments on the first death should always be considered fully to cover the following situations, and to weigh up the overall optimum planning, including giving consideration to the best use of the nil-rate band on the death of the first spouse or civil partner:-

·       the timing of financial provision for beneficiaries – what are their needs now?

·       to redress inadequate financial provision

·       to pass inheritance on to the next generation where the immediate beneficiaries are already wealthy

·       general family circumstances

 

Post Death Adjustments can be effected by any of the following means:

·         Claiming / Disclaiming Legal Rights

·         Executing a Deed of Variation

·         Discretionary Will Trust

 

 

Acknowledgement is hereby made of the following reproduction of H M Revenue & Customs materials, protected by © Crown copyright.

 

(1)     Legislation has been introduced in the Finance Bill 2008 to allow a claim to be made to transfer any unused IHT nil-rate band on a person’s death to the Estate of their surviving spouse or civil partner who dies on or after 9th October 2007.  This will apply where the IHT nil-rate band of the first deceased spouse or civil partner was not fully used in calculating the IHT liability of their Estate.  Where the surviving spouse or civil partner dies, the unused amount may be added to their own nil-rate band.

 

(2)     A transfer of unused nil-rate band from a deceased spouse or civil partner (no matter what the date of their death) may be made to the Estate of their surviving spouse or civil partner who dies on or after 9th October 2007.

 

(3)     Transfers of property between spouses or civil partners are generally exempt from IHT.  This means that someone who dies leaving some or all of their property to their spouse or civil partner may not have used up their nil-rate band fully.  The new rules will allow any nil-rate band unused on the first death to be used when the surviving spouse or civil partner dies. 

 

(4)     The amount of the nil-rate band potentially available for transfer will be based on the proportion of the nil-rate band that was unused when the first spouse or civil partner died.

 

(5)     Some examples:-

·         On the first death, none of the original nil-rate band was used because the entire Estate was left to a surviving spouse.  Then if the nil-rate band when the surviving spouse dies is £350,000, that would be increased by 100% to £700.000.

·         If on the first death, the chargeable Estate is £150,000 and the nil-rate band is £300,000, then 50% of the nil-rate band would be unused.   If the nil-rate band when the surviving spouse dies is £350,000, then that would be increased by 50% of £350,000 to £525,000.

·         J dies on 27 May 2007, with an Estate of £300.000.  She leaves legacies of £40,000 to each of her three children with the remainder to her spouse K.  The nil-rate band when J dies is £300,000.  K dies on 15 September 2009 leaving his Estate of £500.000 equally among his three children; the nil-rate band when K dies is £325,000.  J used up 40% of her nil-rate band when she died (i.e. 3 legacies of £40,000 to children = £120,000 using nil-rate; and £180,000 to spouse) which leaves 60% available to transfer to K on his death.   So K’s nil-rate band of £325,000 is increased by 60% = £195,000, to £520,000.   As K’s Estate is only £500,000, there is no IHT to pay on K’s death.

·         X dies on 14 April 2007 with an Estate of £250,000, leaving £120,000 to his son Y, and the remainder £130,000 to his spouse Z.  The nil-rate band when X dies is £300,000, so 60% of his nil-rate band is unused (i.e. legacy to son £120,000 using nil-rate out of possible £300,000).   Z later marries W who dies on 14 May 2008 and also leaves 60% of his nil-rate band unused.  Z dies on 14 June 2009 with an Estate of £700,000 when the individual nil-rate band is £325,000.   Z’s nil-rate band is increased to reflect the transfer from X and W, but the amount of increase is limited to 100% of the nil-rate band in force at the time.  So Z’s nil-rate band is £650,000, leaving £50,000 chargeable to IHT on Z’s death.

 

(6)     The amount of additional nil-rate band which can be accumulated by any one surviving spouse or civil partner will be limited to the value of the nil-rate band in force at the time of their death.  If someone has survived more than one spouse or civil partner, then on their death the accountable persons may be able to claim additional nil-rate band from more than one of the relevant Estates. This may also be relevant where a person dies having been married to, or the registered civil partner of, someone who had themselves survived one or more spouses or civil partners.

 

(7)     Personal representatives will not have to claim for unused nil-rate band to be transferred at the time of the first death.  Any claims for transfer of unused nil-rate band amounts will be made by the personal representatives of the Estate of the second spouse or civil partner to die, when they make an IHT Return.   A separate claim form IHT216 should be completed for each spouse or civil partner who died before the deceased.

 

(8)     Records about the Estate on the first death will need to be kept in order to support a claim when the surviving spouse or civil partner dies – the documents which have to be produced are:-

·         Marriage certificate for the couple

Plus the following relating to the first spouse or civil partner to die:-

·         Death certificate

·         Copy of Confirmation of Executors

·         Copy of Will

·         Copy of any Deed of Variation relating to Estate

See form IHT 216 for full details of information required to make a claim.

 

(9)     Remember that, even if all of the assets passing under the Will are left to the surviving spouse or civil partner, there may be other components of the aggregate chargeable ‘Estate’ on death for IHT purposes (e.g. assets in Trust, gifts, assets passing by survivorship) which have used up some or all of the nil-rate band, thereby reducing the amount of unused nil-rate band that may be available for transfer.

 

(10) The rules apply in the same way, whether the first spouse or civil partner to die left a Will or died intestate.

 

 

Therefore to summarise all of the above:-

 

In our Example of the use of a Deed of Variation in pages 2 and 3 above

If it suited the financial circumstances of the widow to retain the whole funds from her husband’s Estate until her own death, and/or if the daughter was not in immediate financial need of the Legacy of £312,000 from her father’s Estate, then the opportunity now provided, to transfer the unused nil-rate band from the father’s Estate to the widow’s subsequent Estate, should be considered fully along with all other possibilities.

 

 

The importance of Making a Valid Will

It is important to make a valid Will, taking all relevant intentions into account, and to update your Will whenever your intentions and circumstances change.

 

 

Gifts into Settlement (Trusts)

There are various types of Trust vehicles available, where substantial outright lifetime gifts are not considered to be suitable for the donor’s purpose.   Depending on the type of Trust appropriate, there are Inheritance Tax, Capital Gains Tax and Income Tax implications to be considered, therefore each situation much be tailored to suit the Client’s specific personal needs.

 

 

Conclusion

The foregoing is a summary of the opportunities open to individuals to plan to minimise Inheritance Tax liability.  It should be considered as a general introduction to the subject and cannot cover all eventualities.  It is recommended that any proposed individual planning should be discussed in detail with the appropriate professional adviser, so that every aspect of the client’s financial circumstances and overall taxation implications can be sensitively and confidentially considered.