Financial, wealth and tax planning was a recent topic of conversation in our offices, a subject made more topical by the media burst of interest over the recent government announcement regarding state funding for elderly and social care.
Thousands more people will pay inheritance tax (IHT) to fund a watered-down version of the Dilnot plan for universal state funding for elderly and social care. Pensioners and disabled adults will have to pay up to £75,000 of any care bills they incur before the state steps in under the new arrangement. The new measures will directly affect IHT, in that the proposed changes will be funded by maintaining a freeze until 2019 the IHT tax threshold, commonly referred to as the nil rate band (NRB).
WEALTH PLANNING AND IHT
I want to focus on a particular aspect of Wealth planning, namely IHT, a tax that is bringing more people into the tax net. If we have good fortune and health, then we will all become elderly, however comfort and quality of expected lifestyles will be dependent on a number of factors, personal financial, wealth and tax planning being one of them.
IHT is, perversely an avoidable tax, if some planning and consideration is applied – even if planning is not carried out during your lifetime it is still possible to mitigate the effects of IHT at death, for example rewriting wills.
The UK IHT regime affects those that are considered UK domiciled (actual or deemed), and IHT will normally be applicable if the value of your worldwide estate at death and transfers over the last 7 years exceed the NRB, currently for the tax years 2012-13 to 2014-15 this will be £325,000. It is estimated that the proposed freezing of the band until at least 2019 will bring 5,000 more families a year into the tax trap. It will increase IHT bills by an average £95,000 compared to what they would have been had the allowance had been increased as planned.
GIVING AWAY YOUR WEALTH WHILE STILL LIVING
Lifetime transfers are divided into two groups, potentially exempt transfers (PET) and chargeable lifetime transfers (CLT).
NO IHT TO PAY WHILE STILL LIVNG
Any transfer that is made to another individual is classified as a PET; a PET only becomes chargeable to IHT if the donor dies within seven years of making the gift. If the donor survives for seven years then the PET becomes exempt and can be completely ignored.
If the donor dies within seven years of making a PET then it becomes chargeable. Tax will be charged according to the rates and allowances applicable to the tax year in which the donor dies. However, the value of a PET is fixed at the time that the gift is made.
POSSIBLE IHT TO PAY WHILE STILL ALIVE
Any transfer that is made to a trust is a chargeable lifetime transfer, a trust is a widely used legal device and arises where a person transfers assets to people (the trustees) to hold for the benefit of other people (the beneficiaries). For example, parents may think that gifting assets and wealth to their offspring presents too much of a temptation for them. Instead, assets can be put into a trust with the trust being controlled by trustees until their offspring are older.
Unlike a PET, a CLT is immediately charged to IHT based on the rates and allowances applicable to the tax year in which the CLT is made; if chargeable it will be at 20% (current life time rate). An additional tax liability may then arise if the donor dies within seven years of making the gift. Just as for a PET, the value of a CLT is fixed at the time that the gift is made, but the additional tax liability is calculated using the rates and allowances applicable to the tax year in which the donor dies.
Unlike capital gains tax where, for example, a principal private residence is exempt, all of a person’s estate is generally chargeable to IHT.
TAX LIABILITY ON DEATH ESTATE
A person’s estate includes the value of all UK and wordlwide assets which they own at the date of death, such as property, shares, motor vehicles, cash and other investments. A person’s estate also includes the proceeds from life assurance policies even though these proceeds will not be received until after the date of death. The actual market value of a life assurance policy at the date of death is irrelevant.
RATES OF TAX
IHT is payable once a person’s cumulative chargeable transfers over a seven year period exceed the NRB. For the tax year 2012–13 & 2013-14 the NRB is £325,000, the rate of IHT payable as a result of a person’s death is 40%. This is the rate that is charged on a person’s estate at death, on PETs that become chargeable as a result of death within seven years, and is also the rate used to see if any additional tax is payable on CLTs made within seven years of death.The rate of IHT payable on CLTs at the time they are made is 20% (half the death rate).
SOME THINGS TO CONSIDER
MAKE A WILL
• Making a will and being sure people know where to find it is the first step to making sure that your estate is shared out exactly as you want it to be when you die.
• If you don't leave a will, your estate will be shared out among your next of kin according to a strict order of priority called the 'rules of intestacy'.
GIVE WEALTH AWAY WHILE STILL LIVING
Lifetime transfers are the easiest way for a person to reduce their potential IHTliability.
• A PET is completely exempt after seven years.
• A CLT will not incurany additional IHT liability after seven years.
• Even if the donor does not survive for seven years, taper relief will reduce the amount of IHT payable after three years.
• The value of PETs and CLTs is fixed at the timethey are made, so it can be beneficial to make gifts of assets that are expected to increase in value such as property or shares
• Consider equity release
• Put life assurance policies under trust
• Not just for the rich and famous
• There are certain investments that become IHT free after 2 years. Qualifying AIM shares is one, and Enterprise Investment Schemes are another. After a period of two years, the value of any EIS investment will be outside that person's estate, therefore after death, beneficiaries will receive 100 per cent of the return. This is known as Business Property Relief.'
• Taper relief reduces the amount of tax payable where a donor lives for more than three years, but less than seven years, after making a gift, taper relief ranges from 20% to 100%.
• Transfer of a spouse’s & registered civil partners unused NRB
• Intra-spouse transfers are exempt from IHT (and CGT)
• Small gifts exemption (up to £250 per annum per donee while alive)
• Annual exemption of £3,000, unused annual exemptions available to carry forward
• Normal expenditure out of income, IHT is not intended to apply to gifts of income.
• Gifts in consideration of marriage, up to £5,000 if made by parent gift; £1,000 if anyone else
In future blogs we will look at the subject of Capital Gains Tax and the relationship with IHT. I hope you found this information useful and as with all these things, it of general application. More news and stories can be found on this site, future blogs and by connecting to me on Linkedin http://www.linkedin.com/profile/view?id=60867303&trk=hb_tab_pro_top