Inheritance Tax (IHT)

Inheritance Tax is a tax that is levied on your estate when you die and pass your estate to your beneficiaries. Transfers to your spouse are exempt, and so for the vast majority of people IHT is a tax levied on the death of the longest living spouse.

It is calculated by working out the value of your entire world-wide assets if you are UK domiciled, and then levying tax as follows (for 2005/06):

- First £0-285,000 Nil Rate Band (no Inheritance tax)
- Over £285,000 40% (no tax on that part of the estate within the Nil Rate Band)

Example Tax Calculation - on an estate of £400,000 the tax would be £46,000

Your estate includes all of your property, investments, home etc, (wherever in the world they are located), but for practical purposes it does not include business assets such as farms (where you are the owner occupier or tenant), unincorporated businesses, unlisted or AIM listed companies. To be fair however, there is much devil in the detail and if you class yourself as a businessperson, entrepreneur or landlord you should have a full analysis carried out.

The Most Common IHT Avoidance Idea that Doesn't Work

Giving something away but keeping it really. This comes in many guises, the most common being to try to give your house to your children while being allowed to live in it until you die, giving a valuable work of art to your children but actually keeping it on your wall, or putting money into a trust where it is possible for you to get it back out.

All of these ideas fall foul of the Gift With Reservation rule. Broadly speaking this means that a gift is not a gift if the donor retains any actual or potential benefit from the gift, ie the house as a home, appreciating the art, the ability to access the money.

The Most Common Inheritance Tax Avoidance Technique that Does Work - Using the Nil Rate Band

Most couples simply pass all of their assets to each other on first death, and then it goes to the children. This means that the Nil Rate Band of the first person to die is wasted.

If you have enough spare assets to pass funds to your children on first death without adversely affecting the survivor you can use both of your Nil Rate Bands. Even if you can't afford to gift direct to children you can arrange for assets up to nill rate band to go into a discretionary trust on 1st death, written so as to allow surviving spouse access to funds.

What you do, as a couple, is write your Wills so that any funds that are not needed by the survivor can be passed to children on the first death. Since you can pass the value of the Nil Rate Band without incurring any Inheritance Tax liability normally the phrasing in the Will will state something like "to our children in equal shares, the current value of the Nil Rate Band, up to a limit of £350,000". It is important to keep the Wills under review, either to increase the limit, or, if circumstances change for the worse, reduce it. Using this technique tends to be all that most couples with estates worth under £500,000 need do.

Large Estates

These need to be looked at with great care. In essence the practical approach will be some or all of:

Giving assets away while alive, be it to Trusts, charities, friends or family

In short you can give away as much as you like to whomsoever you wish and if you live 7 years after the last major gift all Inheritance Taxes on those gifted assets will be avoided. That said in disposing of assets by gift there may be immediate Capital Gains Tax implications. Also Trusts need to be treated with much more care than most people think (use the wrong one and its internal tax rate may obviate any apparent Inheritance Tax savings, or inflexible deeds may prevent you disposing of your assets as you wish). Advice and planning is essential.

Providing for IHT by means of life insurance

The liability is estimated (net of any Will and Gift based planning) and a life insurance policy is taken out that pays out the amount needed for tax. This is paid into trust and so falls outside the estate. This is most widely used where the estate comprises large assets whose sale or break-up is to be avoided so that they can be passed intact down the generations (typically a family property, art, antiques etc).

Avoidance Plans

From time to time the insurance companies are able to create packages that manage to let you have some benefit from your assets while at the same time placing them outside your estate or in some other way enhancing your tax planning. It is fair to say that the Government is not keen on some of these schemes and so each Budget normally contains some loophole-closing legislation. Whether there are any current schemes suitable for you is something that can be discussed during our meeting.

If you have an estate for which Inheritance tax may be an issue it is important to seek advice and plan in advance. We will be able to assist you in this.