A Guide to Inheritance Tax & Estate Planning

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1 A Guide to Inheritance Tax & Estate Planning Understand the importance of putting your affairs in order Understand how Inheritance Tax works. Understand the different opportunities available to you to reduce your liability to Inheritance Tax.

2 Planning ahead Planning for the future allows you to set out clearly who should get what from your estate, but if your estate is worth more than the Inheritance Tax (IHT) threshold then it is important to consider maximising IHT reliefs and exemptions. This Guide is designed to outline what IHT is, who needs to be concerned, how it works and also highlight some of the allowances you can use to help to mitigate its effects on your estate. You can take some basic steps to ensure that you make full yet practical use of your allowances and exemptions. The importance of making a Will Making a Will is the first step to protecting your loved ones and enables you to ensure that your estate is shared out exactly as you would want it to be. If you die without making a Will, your estate will be shared out amongst your next of kin according to a strict set of rules called the 'rules of intestacy'. This means that people you would want to benefit from your estate might get nothing. We refer you to our What happens if I die without making a Will flowchart which illustrates the intestacy rules in more detail. What about a Lasting Power of Attorney? A Lasting Power of Attorney is a document by which you give someone else (known as the Attorney) power to make decisions on your behalf. There are two types of Lasting Power of Attorney one deals with the Property and Financial Affairs and the other deals with Health and Welfare. We direct you to our Guide to Lasting Powers of Attorney which explains this subject in more detail. What is Inheritance Tax? IHT is usually paid on your estate when you die. Occasionally, it can be applied to trusts or gifts made during your lifetime. IHT is charged on your estate after you have died. Your estate comprises the value of your home, any other property, shares and investments, cash and your personal belongings, for example, jewellery, motor car, book or stamp collections. Most estates will not be subject to IHT because they re valued below the threshold. The Inheritance Tax threshold is 325,000 (2015/16) and will remain so until April IHT is payable at 40% on the amount over this threshold or for deaths after 6 April 2012, 36% if the estate qualifies for a reduced rate as a result of a charitable donation. The initial, tax free 325,000 is referred to as the nil rate band. As a general rule, IHT is due to be paid to HMRC 6 months after the date of death. Interest is payable (and sometimes penalties) if the IHT is not paid within that time period. There is a special scheme allowing banks to release funds in the deceased s accounts to pay IHT before Probate or Letters of Administration have been granted. For certain types of property (such as the family home) there are options allowing payment to be made by up to 10 annual instalments or until the property is sold. For more information about Grants of Probate or Letters of Administration, we refer you to our Practical Guide for Executors.

3 Spouses and Civil Partners With effect from October 2007, married couples and registered civil partners are able to increase the nil rate band on their estate to as much as 650,000 when the second partner dies ( 325,000 x2 for the tax year 2015/16). This is known as the transferrable nil rate band. This means that on first death, if you leave everything you own to your surviving spouse or civil partner in this way: your whole estate would be exempt from IHT, and your nil rate band remains unused. That unused nil rate band is therefore available to increase the nil rate band of your spouse or civil partner when they die even if your spouse had re-married. Your spouse or civil partner s estate can therefore be worth up to 650,000 in 2015/16 before any IHT is applicable. In practice, the executors or personal representatives must apply to HMRC within 24 months of your spouse or civil partner s death to transfer your spouse or civil partner s unused nil rate band. The introduction of the Main Residence Allowance George Osborne announced in the Budget on 8 July 2015 the introduction of a main residence allowance (sometimes referred to as the family home allowance) for deaths occurring after 5 April 2017 of up to 100,000 ( 175,000 from April 2020) which will be available to those leaving their residence to their direct descendants such as a child or a grandchild. This will initially be 100,000 in 2017/18, rising to 125,000 in 2018/19, 150,000 in 2019/20, and 175,000 in 2020/21. It will then increase in line with CPI from 2021/22 onwards. The additional band can only be used in respect of one residential property which has, at some point, been a residence of the deceased. This creates an effective 500,000 IHT threshold for estates in 2020/2021 ( 325,000 plus 175,000). Any unused nil rate band may be transferred to a surviving spouse or civil partner. It will also be available when a person downsizes or ceases to own a home on or after 8 July 2015 and assets of an equivalent value, up to the value of the additional nil rate band, are passed on death to direct descendants. There will also be a tapered withdrawal of the additional nil rate band for estates with a net value (after deducting any liabilities but before reliefs and exemptions) of more than 2 million. This will be at a withdrawal rate of 1 for every 2 over this threshold. The allowance will not apply in full to estates over 2 million. Minimising Inheritance Tax: Inheritance Tax Exemptions and Reliefs If the value of your estate exceeds a certain threshold, you become liable for IHT on the excess amount, currently payable at 40%. This may be a source of financial hardship to those you leave behind, especially when a house or other property must be sold in order to pay the tax bill. There are several exemptions and reliefs available to mitigate the impact of IHT. Some of the possibilities available include:

4 Spouse or Civil Partner Exemption IHT is not payable on anything left to a spouse or civil partner who has their permanent home in the UK, nor on lifetime gifts made to them. Please note that there are no similar exemptions for cohabitees or siblings who live together. Special care needs to be taken when drafting Wills for these people to avoid being taxed twice on the same asset. UK Charity Exemption Any gifts made to registered charities in the UK, whether they are over a period of time or stipulated in your Will, are exempt from IHT. The 7 Year Rule & Taper Relief Many people seem to be aware of a 7 year rule in relation to lifetime gifts, but do not have any details regarding the nature of this rule, there are many widespread misunderstandings regarding how this rule actually works. You are able to make gifts to individuals, which will be exempt from IHT provided that you outlive the gift for 7 years. This type of gift is known as a Potentially Exempt Transfer (PET). If you die within 7 years and the total of the gifts you have made is less than the IHT threshold ( 325,000 in 2015/16), the value of the gift is added to the estate and any IHT due is paid out of the estate. If you die within 7 years of making the gift and the gift is more than the IHT threshold ( 325,000 in 2015/16), IHT is paid on the value of the gift, either by the donee (i.e. the recipient of the gift) or by the personal representatives of the estate. If you die between 3 and 7 years after making the gift and the total value of the gift paid is over the IHT threshold, Taper Relief may apply to reduce the impact of the gift. It is important to note that Taper Relief only applies to the amount in excess of the nil rate band. The following shows how Taper Relief may work: Number of years between the date of gift and the date of death Taper Relief % Applicable 3 20% 4 40% 5 60% 6 80% Once you have made the gift you should not have any further benefit from it otherwise you may fall foul of the gift with reservation of benefit rules. This means that the full value of the asset will remain part of your estate for IHT purposes. Full records of the date, recipient and size of the gift must be kept to enable your executors to complete the IHT forms and make a full disclosure to the Revenue. The 3,000 Annual Allowance You are able to give away up to a maximum of 3,000 each year, either as a single gift or as several gifts adding up to that amount. Any remaining allowance from the previous year can also be used.

5 The 250 Small Gifts Exemption Small gifts of up to 250 can be made taxfree, to an unlimited number of individuals. Please note that the 3,000 Annual Allowance and the Small Gifts Exemption cannot be combined. Gifts on Marriage If you are giving gifts to someone who is getting married or registering a civil partnership, they are exempt depending on your relationship to them as follows: 5,000 to each child; 2,500 to each grandchild or great grandchild; 1,000 to anyone else. You must make the gift (or promise to make it) on or shortly before the date of the wedding or civil partnership ceremony. If the ceremony is called off and you still make the gift or if you make the gift after the ceremony without having promised first, the exemption will not apply. Business Property Relief and Agricultural Property Relief Business Property Relief (BPR) can be claimed on certain types of business or business assets. The business must fall within one of the categories of relevant business property and have been owned for a minimum period. There is relief of up to 100% on business property as long as the property has been owned for 2 years. Some business assets in certain cases may only qualify for 50% Business Property Relief. Business Property Relief extends to unquoted shares, forestry and agricultural land. The shares must be in trading companies to qualify for Business Property Relief so resource or property companies do not qualify. Shares listed on the AIM market (Alternative Investment Market) are effectively IHT free once they have been owned for 2 years. Due to the nature of the underlying investments, AIM portfolios can be high risk investments. A Financial Planner would be able to discuss this aspect of things in more detail with you. Agricultural Property Relief (APR) is available on the agricultural value of certain property. For the purpose of this relief the property must be in the UK, Channel Islands or the Isle of Man. In general, it can include agricultural land, building required for agricultural purposes, woodland and growing crops transferred with the land. The property can be owner occupied or let and the relief is only available if the property has been owned for a minimum period. Your Accountant or Tax Advisor should be able to provide you with more detailed advice on whether either BPR or APR could apply in your circumstances. Regular Gifts from Surplus Income Gifts that are funded by normal expenditure out of your income can be exempt from IHT. Relief is not given automatically in these circumstances, it must be claimed by your personal representatives. For the claim to be accepted by HMRC, you will need to be able to show that the gift is part of your normal expenditure and not funded out of capital.

6 If your standard of living has been significantly reduced or your savings depleted in order to fund the gifts, relief will not be applied. These gifts can be for as much as you like but they must form part of a pattern of giving and HMRC must be satisfied that after the gift has been made you are left with sufficient income to maintain your existing standard of living. There must be a settled intention to make regular gifts for example, you should write a letter to make the commitment or establish a pattern e.g. the payment of annual premiums on a life policy for the benefit of someone else or written in trust for the beneficiary. You are able to stop making the gifts if your circumstances change, for example, if you need more income to pay for care. The exemption is established as soon as the payments are made and this means that if you stop making the gifts you do not lose the exempt status of those you have already made. Income will include salary, rent received, dividend income from shares, and interest paid on a bank or building society account. Note that it is net income after tax has been paid. The gifts are made by an individual and not pooled as a couple. The exemption may be combined with other exemptions. Your personal representatives would need to claim the exemption by completing form IHT403. It is useful to obtain this form ( ) and to provide the details of the gifts on an ongoing basis. This will enable your personal representatives to claim it after you have died. If you do not keep proper records, your personal representatives will not be able to establish this exemption. Maintenance payments Exempt maintenance payments may be made to: Your ex-husband, ex-wife or former civil partner. Relatives who are dependent on you because of old age or infirmity. Your children, including adopted children and stepchildren, who are under 18 or in full time education. Note that full time education may continue to an age well beyond 18. Military Personnel The estate of someone killed on active service is exempt from IHT. You should note that the death does not need to be instant and the injury does not need to have been the sole cause. Other Options to consider: Take out an Insurance Policy If you are able to estimate the size of your IHT bill, you may wish to consider the possibility of taking out an insurance policy to cover all or part of it. In setting up a specific whole-oflife insurance policy written into trust, you can ensure that your personal representatives are provided with a lump sum, in the event of your death, that lies outside your estate. If the policy premiums are treated as a gift from income they are exempt from IHT. By insuring against IHT, you retain ownership of your wealth and can use it should you need to, which is an attractive alternative to reducing the size of your taxable estate. A Financial Planner would be able to assist you

7 with this. It is a good idea to carry out a financial health check at the same time to discover what other tax planning opportunities might be available to you. Nomination of Pension or Policy Lump Sums If you die whilst you are employed but before you have drawn down your pension, there will usually be a lump sum payment to be made. Pension Fund Trustees are faced with the decision as to who benefits from the death in service and other lump sum benefits. You may have nominated your spouse or children to receive the lump sum benefits. If children have been nominated and they are under 18 when you die before pensionable age, a trust is required to hold the fund until each child is 18. It is usually possible to nominate someone of your choice to receive the death benefit under an insurance policy or death in service claim. You would need to complete an Expression of Wish or Nomination of Beneficiary form with the company concerned. This payment normally passes outside of the estate and therefore will be exempt from IHT. You should bear in mind that if all of the death benefits pass to your surviving spouse, their estate will be increased and the IHT on their death will therefore be greater. It is possible to save the extra IHT while at the same time arranging for your spouse to have the benefit of the money as follows: During your lifetime, you would need to set up a Discretionary Trust with a nominal sum of 10 (this is known as a Pilot Discretionary Trust or a Spousal Bypass Trust ) and nominate that the death benefits are to be paid to this Trust, rather than your surviving spouse outright. Your spouse (in their capacity as widow/er) would be a potential beneficiary of this Trust and may also be one of the Trustees. If you were to die before drawing a pension, the Pension Fund Trustees will pay the death benefits to the Trustees of the Trust rather than paying the death benefits direct to your surviving spouse and/or children outright. The Trust would need to be registered with HMRC at this point as it would have assets of more than 10. The Trust is a separate legal entity and as such attracts its own taxation. The Trustees would decide who receives the income and can distribute capital if needed or even make loans from the trust if appropriate. Your surviving spouse can receive payments of income from the trust, but the underlying funds are not treated as theirs when they die, thus potentially saving 40% of the value of the trust fund. Payments can also be made to your children. Capital can be paid out if needed. The Trustees could also make a loan to a beneficiary. Directions as to how you would like the funds in the trust to be distributed can be set out in a separate accompanying side letter.

8 The Importance of Keeping Records It is essential to keep proper records to enable your personal representatives to claim the proper exemptions. Remember that your personal representatives will be making the claims after you have died and you would be unable to clarify matters or provide further information. What should I do now? There are many opportunities available to you to reduce your IHT liability by planning during your lifetime but of course, any IHT planning is dependent upon your circumstances. Careful planning and practical advice is imperative when you are taking steps to reduce your estate for IHT purposes. Look at your financial circumstances and assess your potential IHT liability. Is there any scope for making any lifetime gifts? The underlying philosophy for IHT is that gifts by an individual will be exempt provided you survive for 7 years. Remember that the gifts must be outright gifts with no reservation of benefit. Ensure that you have taken advantage of the annual allowance or other IHT exemptions and reliefs. Consider whether your Life Assurance and Pension arrangements do not aggravate any potential IHT. Wills should be made. Any existing Wills should be kept under constant review. For individual advice and assistance contact our Wills, Trusts and Probate Team to find out how we can help. Disclaimer - This guide contains information on current legal issues applicable at the time of printing. Note there may have been changes subsequently which have not been incorporated into the material. This guide is intended for information purposes only and its content should not be applied to any particular set of facts or relied upon without legal or other professional advice. Why choose Band Hatton Button? We deliver excellent legal services with a human touch and are proud to have a reputation for being approachable and going the extra mile for our clients. We provide high quality, pragmatic advice and offer a comprehensive range of legal services, delivered by experts and supported by our culture of respect and understanding. Our expertise includes: Trust creation and administration; Wills, estate and succession planning; Will disputes; Powers of Attorney and Court of Protection; Matrimonial and family law; and Administration of estates and post death planning; Buying or selling a property. 25 Warwick Road Coventry CV1 2EZ DX Coventry info@bandhattonbutton.com