Preserving your wealth

Make sure your heirs are not left facing an unexpected tax bill

Many UK households could be at risk of paying inheritance tax (IHT), the tax which is charged at 40 per cent on the value of your estate over the nil-rate band threshold – currently £312,000 for an individual and £624,000 for a married couple, (2008/09 tax year).

The government has reversed many popular IHT schemes during its term in office. Tens of thousands of families who set up home-loan trusts to avoid the tax were affected by a crack-down on preowned assets in 2005.

A tax to discourage the use of certain types of trusts was also announced in 2006, and in 2007 the government announced it would be paying closer attention to lifetime gifts.

Many families do not start thinking about IHT planning until it is too late, so the first thing to do is to work out if the tax will be an issue. Add up the value of your savings, investments, properties and other personal possessions. Don’t forget to include funds held in an Individual Savings Account (ISA) wrapper. Although an ISA is tax-free during your lifetime, they are subject to death duties. You only pay tax on the value of your estate over the nil-rate band threshold. In the 2008/09 tax year the threshold is £312,000.

IHT is not payable when an estate passes between a husband and wife, or from one civil partner to another. Even better, married couples or civil partners can transfer the unused element of their IHT-free allowance to their spouse when they die. A couple would escape tax on £624,000 (2008/09) by doubling up the allowance this financial year. In 2010, when the nil-rate band threshold rises to £350,000, a married couple would escape tax on £700,000.

Giving away assets during your lifetime is a simple and legitimate way to mitigate potential death duties, as long as you do it in time. You can gift up to £3,000 a year and it is immediately exempt from IHT, or £6,000 if you did not make a gift of this kind in the previous tax year.

A married couple giving for the first time could, therefore, hand over £12,000 to their children in one year. After that, the maximum for a couple is £6,000. You can also escape IHT by giving £250 to any number of people every year, but you cannot combine it with the above exemption.

Parents can give £5,000 to each of their children as a wedding or civil partnership gift. Grandparents can give £2,500 and anyone else £1,000. Gifts of any size to political parties or charities are also exempt. If a gift is regular, comes out of income and does not affect your standard of living, any amount of money can be given away and ignored for IHT.

It is possible to make further tax-free gifts known as potentially exempt transfers (PETs), but you have to survive for seven years after making the gift. If you die within seven years and the gifts are valued at more than the nil-rate band threshold, you apply taper relief. The tax reduces on a sliding scale if the gift was made between three and seven years earlier.

You can give away most assets, including cash and shares. However, it has to be an outright gift from which you can no longer benefit. This excludes giving away your family home. If you hand it to your children and continue to live there, you have to pay a market rent, which can wipe out the tax benefits. Always make a note of such gifts to pass on to the executor of your will.
Loan trusts are designed for people who cannot give away assets because they need to live off the income but want future investment growth to be IHT-free.
You make a payment to a trust, which is treated as an interest-free loan to the trustees. The trust then repays your loan capital in instalments, giving you an income.

When you die, any outstanding loan forms part of your estate, but all investment growth is free from tax.
If you want to give away assets, and need to draw an income but do not think you will need the capital, you could consider discounted gift trusts. You make a gift into a single-premium insurance bond for your children, fixing how much income you will draw until your death. If you survive for seven years, the bond does not count as part of your estate.

Some investments offer tax benefits. Most shares listed on the Alternative Investment Market (AIM) become free from IHT once you have held them for two years. This is because they qualify for business property relief. There are risks, as AIM stocks can be extremely volatile, but the value of your portfolio would have to fall by 40 per cent or more before you would lose the IHT benefits.

Money invested in a commercial forest or actively farmed land also becomes free of IHT after you have owned it for two years. Commercial woodland is defined as property where timber from the forest will be actively marketed and sold.

If at any time you are unsure about how much risk you are prepared to take and what approach is appropriate for your particular situation, you should speak to us to receive professional advice.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.