Inheritance Tax: the correct strategy for your estate...and your family By Colin Yule 1
The right of Colin Yule to be identified as the author of the ensuing work has been asserted by him in accordance with the Copyright Act 1988 The opinions and information presented within this document are the opinions of Colin Yule and the company, CM Charterhouse Associates Ltd. This document does not constitute financial advice under the Financial Services & Markets Act 2000, and it is recommended that you should seek the appropriate professional advice on savings, investments, and tax planning. All the information within this document is correct at time of issue, July 2015. Contents Introduction Exemptions Changes from 2016 Your Questions answered 2
A Guide to Successful Inheritance Tax Planning Many people prefer not to think about what`s ahead of them, especially as considering their immortality is filled with morbid associations. However the price of doing nothing could be very high indeed, and with serious repercussions on your family and loved ones. None of us know exactly when the clock will stop, and many estates are caught in a financial trap because individuals were unprepared for this eventuality. In the world of estate planning and inheritance strategies, there are many misconceptions by the public usually caused by advice being offered by another who is either unaware of the succession laws and the complexities of such, or has a financial interest in the estate, or simply presumes that a specific strategy that worked for them will also do the same for you. Most families` circumstances differ, and it is so important that any succession strategy is tailored to meet their individual circumstances and wishes. Prudent individuals will prefer to consider action without any unnecessary delay, rather than just hoping for the best. Hopefully, reading this guide in its entirety could prove to be one of the better decisions that you will make in your lifetime. 3
Inheritance Tax (IHT) To quote Benjamin Franklin the only things that are certain in life are death and taxes. Unfortunately, inheritance tax can touch on both of these. When you die, the Government assess how much your estate is worth, then deducts any debts to arrive at the net value of your estate. Your estate assets include, but are not limited to: Cash Funds in bank accounts Investments Shares Property you own Businesses you own Vehicles Life Insurance policy payouts Your estate will owe inheritance tax at the rate of 40% on any amount above the current threshold of 325,000. If you leave a legacy to charity, this percentage can reduce to 36% Dealing with this issue can be arranged by some simple actions, and save your estate thousands of pounds. Exemptions from inheritance tax Certain people are exempt from paying inheritance tax, if they die in active service Armed forces personnel, fire-fighters, police, paramedics and humanitarian aid workers. This exemption also exists if the person is injured on active service and their death is hastened by the injury even if they are no longer in active service. Inheritance Tax changes in the July 2015 Budget This prescribed a change in the IHT threshold for homes being passed on after death to children and/or grandchildren. The threshold will rise to 500,000 for a single person and 1,000,000 for a couple and is to be phased in gradually between 2017 and 2020. However, the extra 175,000 allowance (per person) is an extra allowance for the main home residence that is being passed on and does not relate to any other asset values that are being passed on from the deceased`s estate. The way this will actually work in practice requires some consideration, and can be explained as : 4
IHT Changes (continued) Current: The current allowance whereby no inheritance tax is charged is on the first 325,000 (per person) of someone's estate the value of their total assets they leave behind when they die. This remains unchanged. Currently, without the 'main residence' additional allowance, couples can leave a home worth 650,000 without it attracting inheritance tax. Single people couples can leave a home worth 325,000 without it attracting inheritance tax. Above this threshold, the charge is 40%. Changes: A new tax-free 'main residence' band will be introduced from 2017, but it is only valid on a main residence and where the recipient of a home is a direct descendant (which has been classified as children, step-children and grandchildren). It is being phased in gradually, starting at 100,000 from April 2017, rising by 25,000 each year till it reaches 175,000 in 2020. So, in 2017: The maximum that can be passed on tax-free is 850,000 for married couples or those in a civil partnership, and 425,000 for others. For single people, this is made up of the existing 325,000, plus the extra 100,000. For couples, when the first one dies their allowance is passed to the survivor, so that 425,000 is doubled to 850,000 when the second of them dies. In 2020: The tax-free amount will rise to 1m for couples, and 500,000 for singles - as the main residence allowance rises. On properties worth 2 million or more, homeowners will lose 1 of the 'main residence' allowance for every 2 of value above 2m. So for a couple with properties worth 2,350,000 or more, they will get no additional allowance. For the meantime, the remaining guidance given is based on current criteria, and the best way to explain the complexities is to document answers to questions that are frequently asked by the public. 5
If my house is worth less than 650,000, can I forget about IHT? Not necessarily. All your assets (including bank and building society deposits, National Savings & Investments bonds and certificates, and ISAs - individual savings accounts) will be taken into account for the calculation of IHT liability on what is called your estate when you die. Some people might be surprised to learn that assets held in ISAs are included in their estate for the purposes of IHT calculations. It is important to stress that although these may have been tax-free while the saver was alive, they are not tax-free on death. Your estate will be the value of your assets, less any liabilities for example, any mortgage, loan or credit card debts. Gifts made by the deceased less than seven years before death may also be taken into account when calculating your estate because, for the purposes of IHT, any gifts made within seven years of death could potentially reduce the available IHT threshold on death. If all my assets are worth less than 650,000 in total, will this avoid any IHT? Probably not - IHT is calculated on the value of assets at the time of death. So it is a potentially expensive error to assume that because you have no liability for this tax today, that will remain the case for the rest of your lifetime. According to the Office for National Statistics, men aged 65 can expect to live for an average of just over18 more years. If we assume a growth rate of four per cent per annum, the value of the man s assets would have doubled by the time he reached the age of 83. So it is important for you to take professional advice on estate planning and to keep an eye on your asset values to ensure that your estate does not pay more tax than is necessary. What happens if I forget all about IHT and hope for the best? Ignorance of the options is no defence against Inheritance tax liabilities. Be aware that inheritance tax can seriously reduce the amount of inheritance your heirs will receive. Over 3.1 billion taken by the Government for IHT in the 2012/13 tax year in figures published in July 2013 by the Office of National Statistics. According to a Government paper published in June 2013, for the 2012/2013 tax year, an estimated 21,000 estates would have been liable for Inheritance Tax if the estate holder had died. Overall 24.6 billion in Inheritance Tax revenue was collected by the Government between April 2005 and April 2013. 6
Is there an upper limit on Inheritance Tax? No. Indeed, HM Revenue & Customs (HMRC) may end up with a larger portion of an estate than each of the nominated beneficiaries the people named to receive the deceased person s assets. For example, take a widow whose deceased husband fully utilised his own nil rate band allowance of 325,000. She wishes that her three children are to benefit equally after her death. If there has been no planning to reduce any Inheritance Tax liability, her 875,000 estate would result in an inheritance tax liability of 220,000. That is, 875,000 less her nil rate band allowance of 325,000 leaving 550,000 subject to 40% inheritance tax. After HMRC was paid the inheritance tax and this must be paid first that would have left 218,333 for each of the children. In other words, each of the children would have received less than the taxman. Is there any good news on IHT? Inheritance Tax is a tax on the unprepared. But with a little planning and the correct strategies put in place, you should be able to reduce your liabilities or even avoid inheritance tax altogether. In fact, there are so many reliefs and exemptions from Inheritance Tax that accountants sometimes call it the voluntary tax. So, if you would rather see your family and friends benefit from the wealth you have worked hard to acquire, then it makes sense to spend time planning in advance to reduce Inheritance Tax even though nobody likes to think about a subject with morbid associations. Civil Partnerships how does that affect IHT thresholds? Since December 2005, couples of the same sex have been eligible to register their relationship as a Civil Partnership. In general, a civil partner is treated in the same way as a married spouse when it comes to financial and legal matters such as pensions and tax, including IHT. Throughout this guide you will see that the IHT rules that apply to spouses apply equally to registered civil partnerships. Your lifestyle 08 7
Who pays Inheritance Tax and when? Where an estate is liable to Inheritance Tax, this tax must be paid by the beneficiaries before probate (Executry) is granted before the Will is officially recognised. What that means is that any Inheritance Tax liability must be agreed and paid before any assets within the estate are distributed to the beneficiaries. Inheritance Tax payment is due within six months from the end of the month in which the death occurred. After that, interest will usually be added to the tax bill until full payment is made. What if my beneficiaries haven`t the cash to pay the Inheritance Tax bill? As mentioned earlier, assets cannot usually be distributed until the Inheritance Tax bill is fully paid. However, liabilities based on the deceased person s home and any other land or buildings in the estate may (at HMRC s discretion) be paid in instalments over a period of up to 10 years or earlier, when the property is sold. There may be the option to use some of the deceased s accounts to pay monies directly to HMRC. However this is often limited on amounts that can be paid, and which banks/building societies offer this option. One of the more upsetting aspects of Inheritance Tax is that where no action has been taken, the right of HMRC to be paid first may mean that any assets such as the family home have to be sold to pay the tax liability. Could I give my home to my children before I died, and continue to live there? Would it be excluded from my assets in the calculation of Inheritance Tax liability? Unless some other action was taken for example you paid the market rent to your children, and you remained in the property as a tenant - HMRC would most likely regard this action as a gift with reservation, and the transfer would be disregarded which would result in the value of your home being included in your estate when calculating the inheritance tax bill. As a general rule, when assessing Inheritance Tax liabilities, any gift with strings attached is treated as if they had never actually happened. Is there any limit on time for giving away an asset? Inheritance Tax extends to include gifts made within seven years of death. These transfers will only be exempt from Inheritance Tax if the person making the gift(s) lives for seven years after making them. If however, he or she dies within seven years of making a gift, the value is added back into the estate and may be subject to tax at 40%. 8
Time limit on Gifts? (continued) If a donor dies within seven years of making gifts that in total have a higher value than the nil rate band on death, the tax due on any portion over the nil rate band allowance of those gifts can be reduced by a relief called taper relief. This is set out in the box below. Your lifestyle 0 Taper Relief Period of years before death % reduction (taper relief) 0-3 years = No reduction 3-4 years = 20% 4-5 years = 40% 5-6 years = 60% 6-7 years= 80% More than seven years = No tax For example, a person dies three and a half years after making gifts totalling 60,000 to her children. Her estate value on death is 315,000. Since the gifts were made within the 7 years time limit, then the total value of the gifts are added to the estate value, which results in the actual estate value for IHT purposes being 375,000. This means that after deducting the nil rate band full allowance of 325,000, the amount of 50,000 is liable for inheritance tax. However, instead of paying tax at the rate of 40 per cent of the 50,000 surplus over the nil rate band allowance, there is a 20% reduction on taper relief and the recipients of the gifts (the children) would only pay 80% of 40%of the 50,000 surplus, Therefore the children would pay 80% of 40% of 50,000, totalling 16,000. No taper relief is available where the person gifting dies within three years of a gift - and no taper relief is available where gifts in the seven years before death do not exceed the nil rate band allowance at date of death. Are there any gifts or transfers which are free from IHT, no matter when they are gifted? Yes - any genuine gift, however valuable, between spouses/civil partners. These gifts are free of Inheritance Tax, whether they are made before or after death. However, it is a mistake to imagine that couples do not require Inheritance Tax planning. Even though the nil rate band allowance can be transferred between spouses and members of civil partnerships, those with substantial estates or where other circumstances may apply, such as a potential need to protect the family home from liability to fund long-term care fees should obtain professional advice specific to their individual and family circumstances. 9
Are there other exemptions on gifts made before death? The Annual Exemption Everyone is entitled to give away 3,000 in any tax year and for these lifetime transfers to be exempt from Inheritance Tax. Husbands, wives and civil partners have separate allowances and, where the full 3,000 exemption is not used one year it can be carried forward to the next, provided that year s exemption is used first.1 Small Gifts Exemption Any number of gifts up to 250 each can be made in a year and be exempt from Inheritance Tax. It is worth noting that if the total value of gifts to any one person exceeds 250 then all of the gifts to that person must be deducted from the 3,000 Annual Exemption mentioned previously. Gifts from Normal Expenditure Exemption Regular gifts from normal income which do not reduce your standard of living are exempt from Inheritance Tax. There is no maximum limit on the value of this exemption but such gifts cannot be drawn from your capital, such as savings or investments. Nor could they be funded by the sale of an asset. Marriage Gifts Exemption Each parent of a bride or groom can give up to 5,000 Each grandparent or other relative can give up to 2,500 Any well-wisher can give up to 1,000. This exemption class of Gifts must be made before the wedding day. Any other gifts exempt from Inheritance Tax whenever they are made? Philanthropic gifts are covered by the Charitable Donations Exemption. As well as covering gifts of any size to registered charities, gifts for the national benefit for example, the British Museum, National Trust and National Gallery, recognised political parties - are also exempt. So, too, may be gifts of what HMRC recognises as heritage property for example paintings and antiques or buildings of architectural significance where these are donated to museums. In fact, the Government is so keen to encourage charitable donations that as revealed as part of its Budget Announcement in March 2011 it will reduce your Inheritance Tax bill by 10% if you donate at least a tenth of your wealth above the Nil Rate Band allowance to good causes. This change, which came into effect from April 2012, would mean the Inheritance Tax rate applied to your remaining estate would reduce from 40% to 36%. 10
Is there any specific help for business owners, self-employed people, or farmers? Business Property Relief and Agricultural Property Relief can, in certain circumstances, give up to 100% relief against Inheritance Tax. For example, on death a gift of a business as sole trader or partner may be entirely relieved from Inheritance Tax either during their life time or on death. So too may a gift on death of unlisted shares, such as those quoted on the Alternative Investment Market. Similarly, the gift of agricultural land may be relieved of any liability to Inheritance Tax. However, it must be emphasised that the qualifying restrictions are complex and, given the large sums Involved, professional advice should be sought before attempting to make use of these reliefs. Are there any transfers made after death which are always exempt from Inheritance Tax? Payments from company or occupational pension schemes - where the trustees retain discretion about paying beneficiaries - are exempt from Inheritance Tax. That discretion is usually a legal nicety because trustees will generally be guided by the member s statement of wishes. These payments can be substantial - up to 1.25 million tax-free was allowed for the 2014/2015 tax year. Similarly, death benefits from personal pensions and other life assurance policies can be written in trust to exclude them from the policyholder s estate for the purposes of calculating Inheritance Tax. Some people could at least substantially reduce Inheritance Tax liabilities simply by completing a Will or Statement of Wishes, which can be done at modest cost. However, most people will benefit from meetings with a professional adviser who can recommend and implement bespoke or tailor-made strategies to potentially reduce their Inheritance Tax liability. What will happen if I do nothing, and forget all about it? In addition to the Income Tax, National Insurance contributions and perhaps Capital Gains Tax that you will have paid during your lifetime, you may also have to pay Inheritance Tax at 40%. Even quite modest estates can generate substantial tax bills. Remember that the family home and relatively modest savings and investments will often push the estate into an inheritance tax bracket even where the individual concerned did not regard themselves as being rich. However, it is worth emphasising that inheritance tax calculations relate to the estate s assets net of any pre-tax liabilities - after the deduction of any debts. Your lifestyle 11
I think my assets, net of liabilities, are less than 325,000; does that mean I am OK? Not necessarily. One reason that some estates become unexpectedly liable to Inheritance Tax is that none of us knows precisely when our clock will be stopped. The value of your assets and liabilities is likely to fluctuate over your lifetime - the calculation of your net worth today is unlikely to produce the same result at the time of your death. It is very important to make sure that your tax planning keeps pace with the rising value of your assets - because tax exemptions and thresholds may not do so. It makes sense to update your list of assets and liabilities from time to time. In that way, you can keep an up-to-date estimate of the potential tax bill and determine whether your Inheritance Tax planning strategy is still adequate for current circumstances. Are there any other areas of uncertainty I should take into account? To avoid the risk of falling into a false sense of security, it is well to remember that tax rules may be changed at short notice. For example, anti-avoidance rules may be tightened as they have been in recent budgets to make it more difficult for people to give away their assets and reduce their Inheritance Tax liabilities. Alternatively, exemptions could be withdrawn (or reduced) perhaps caused by failing to raise the nil Rate band allowance in line with inflation, or extending the period in which transfers remain potentially liable to tax. And, finally... If you have managed to read all (or most) of this guide to successful succession planning, then you will have realised that to ensure that what you want to happen after your death will actually happen, and to minimise all the many risk factors to your estate & assets, doing nothing is not an option. www.cmcharterhouse.co.uk 12