The Chancellor made three important announcements in the last Budget regarding inheritance tax. Let’s take a look at the impact of these and what action you can take:
(i) the nil-rate band, the starting threshold for inheritance tax, will increase in stages to £325,000 for tax year 2009/10. For tax year 2006/07 it is £285,000.
(ii) the current rules that apply as regards the inheritance tax treatment of lump sum death benefits paid out of pension schemes will continue to apply.
(iii) there will be a substantial change in the inheritance tax treatment of payments made to certain trusts and the way those trusts are dealt with for inheritance tax in the future.
Which means that …
Given the fact that a greater number of people are now fully within the IHT net, it is important to make maximum use of all the planning strategies available:
- the nil-rate band (the cumulative total of non-exempt transfers that can be made by a person without triggering a liability to inheritance tax) increased to £285,000 on 6 April 2006 with a flat rate of tax on death of 40% over that amount. For a person with assets over £285,000 the increase in the level of the nil-rate band will produce a potential increased inheritance tax saving of £4,000.
- the annual exemption, which is kept at £3,000. This exemption is available to each individual.
- you (and your spouse/civil partner) should seriously consider making full use of the IHT exemptions/reliefs available under the current rules, the main features of which are:
- an outright gift of any size between individuals will be a potentially exempt transfer (PET) which means that the gift is exempt from inheritance tax if the donor survives the gift by seven years.
- for those who want some ongoing control a gift of up to the current available nil-rate band into a trust will not suffer any IHT at outset. Although an IHT charge can arise when property later leaves the trust, or on a 10 year anniversary, any such charge is unlikely to be substantial as the maximum tax charge is currently 6%.
- a 100% maximum level of business property relief and agricultural property relief.
- the availability of certain lump sum insurance-based inheritance tax schemes that can provide you with “income” and inheritance tax mitigation but without the gift with reservation rules or the pre-owned assets income tax charge applying.
It is understood that some life offices are reviewing their schemes in light of the proposed IHT changes to trusts but those schemes should become available again in due course.
What action should you consider?
- You should review your Will provisions or (if you do not have one) seriously consider making one. There will often be relatively simple steps that you can take to ensure that you maximise the savings that can be secured for your intended beneficiaries. At current rates of tax, if the first of a married couple/civil partners to die is able to fully use the increased nil-rate band £114,000 could be saved on the death of the second to die.
As you may have read, some of you will need to review your Will with special care as, in some cases, if implemented in the form that it is in, e.g. if it leaves an initial interest to your spouse but gives trustees a wide power to appoint benefits, it could incur unplanned for and unwelcome charges under the IHT discretionary trust regime.
- Gifts made during your lifetime can be extremely effective in reducing the ultimate inheritance tax liability but care is necessary to ensure that the desired savings are achieved. If you own business assets you may, subject to all the very important considerations, wish to make a gift whilst 100% business property relief and agricultural property relief is available. If you are contemplating making substantial outright lifetime gifts in order to save inheritance tax you should do so whilst PET treatment is available.
All growth in the value of the gift will be free of inheritance tax. However, there is also the fact that if no gifts are made there will be an uplift in the value of the assets on death which means that capital gains up to the date of death are “washed out”. This must be taken into account in decision making.
- Gifts to most new trusts now count as chargeable lifetime transfers, for example an accumulation and maintenance trust and a power of appointment interest in possession (flexible) trust. This means that in order to avoid an immediate IHT charge, such gifts should not cause the donor to exceed his IHT nil-rate band (£285,000 for 2006/07) taking account of lifetime gifts made within the previous 7 years which are not PETs or exempt. If you are married both you and your spouse/civil partner can take advantage of the nil-rate band.
Although there could be an IHT charge every 10 years and when capital leaves the trust, the maximum charge at that time (assuming rates do not change) would be 6% and, in many cases, much less than this or even nil.
- By use of a trust, continuing control can be maintained by the donor acting as trustee and, in the case of the flexible trust, maximum flexibility can be included over who will be the ultimate beneficiary under the trust. A life assurance policy can be effected to cover any potential inheritance tax liability on the death of the donor within 7 years.
Careful consideration needs to be given to the capital gains tax implications of making gifts and the capital gains tax cost of making a gift balanced against the potential inheritance tax saving. Following the changes made in this year’s Budget, it will, in general, be possible to defer CGT on gifts of investments to all trusts using hold-over relief.
If cash gifts are to be made into trust, insurance-based investment bonds and other non or low income producing investments can be an attractive trustee investment on tax grounds. This is especially so as the rate of tax applying to trust income and gains is 40% (32.5% on dividends).
- For any lifetime gift to be effective for inheritance tax, it is generally necessary for you (the donor) to be excluded from all benefit in respect of what you have given away. For example, if you give away investments you should not have access to their capital value or any income produced by them. It is the need to satisfy this condition that makes effective inheritance tax reduction difficult for many to achieve. However, certain insurance company schemes seek to overcome this problem by providing you with an “income” whilst providing inheritance tax efficiency on investment growth outside your estate.
Several schemes exist, which are unaffected by the gift with reservation rules and the pre-owned assets income tax charge, and their appropriateness will depend on your objectives and circumstances.
- To the extent that the liability to inheritance tax cannot be reduced by planning, you could consider an appropriate life assurance policy subject to trust so as to provide tax free cash in the hands of the beneficiaries who will have to meet the liability.
If you are married or in a civil partnership and all or most of the liability to inheritance tax will arise on the death of the survivor the recommended policy would be one that pays out at that time. Although, in theory, an IHT charge could arise on payment of the policy proceeds in many cases, because of the way IHT is calculated, no liability should arise.
- The Government has confirmed that provided a person has acted primarily with a view to providing retirement benefits rather than paying death in service benefits to beneficiaries, there should be no IHT liability on lump sum death benefits paid under pension schemes before a person attains age 75.
The Key Considerations
Phew! That’s a lot of information, but we got there.
The new inheritance tax rules in connection with trusts are complex and you will need advice before taking action. This will be true even in connection with a simple life assurance policy held in trust. Feel free to contact us if you want to clarify your current position.
