A GUIDE TO INHERITANCE TAX PLANNING

A GUIDE TO INHERITANCE TAX PLANNING

02 A guide to Inheritance Tax planning CONTENTS Page What is Inheritance Tax (IHT)?...3 What happens if the nil rate band isn t used...3 Included in your estate...4 How much IHT might need to be paid...4 Leaving money to charity...4 Who pays the IHT...5 Making a will...5 Making lifetime gifts...5 What is a trust?...7 Types of trust...7 Next steps...7

03 What is IHT? IHT is a tax which may be paid on your estate (your property, money and possessions) when you die. This tax reduces how much money will pass to your beneficiaries. Your beneficiaries are the people you want to leave your money and assets to when you die. IHT is levied on: UK domiciled individuals or those who are deemed to be UK domiciled individuals in respect of their worldwide assets Non-UK domiciled individuals in respect of their UK assets (with certain exceptions). How does the nil rate band work? No tax is charged on the value of your estate up to the available nil rate band. If your estate is worth more than the available nil rate band when you die, then IHT at the rate of 40% will potentially have to be paid on the amount above this. Other than on death, IHT of up to 20% may need to be paid on certain gifts you make while you are still alive. Each individual who is subject to IHT has an ordinary nil rate band of 325,000 which is expected to be frozen until at least the end of the 2020/21 tax year. From April 2016, individuals who die leaving a property (or a share in a property) in which they have lived, to a direct descendent, may also be entitled to an additional residence nil rate band. The maximum residence nil rate band for tax years up to 2020/21 is shown below: Tax year 2017/18 100,000 2018/19 125,000 2019/20 150,000 2020/21 175,000 Maximum available residence nil rate band When an individual dies, the residence nil rate band that can be claimed is restricted to the value of the property which is being inherited by a direct descendant, after the deduction of any outstanding mortgage against the property. If the deceased owned more than one property which is left to direct descendents, the personal representatives must nominate which one of the properties to use for the purposes of the residence nil rate band. The available residence nil rate band is added to the ordinary 325,000 nil rate band to determine the total available nil rate band. If the maximum residence nil rate band is available, by 2020 your estate could be worth up to 500,000 before any IHT is payable. The following example shows how this works: Mr Williams dies in December 2018, his estate including his main residence, which he owns outright, is left to his daughter and son. His total estate is valued at 1.15 million: Main residence 300,000 Buy-to-let property 250,000 Other assets 600,000 In 2018, the maximum residence nil rate band is 125,000. As his home is valued more than the residence nil rate band, when added to his nil rate band of 325,000, the total he could leave on death without an IHT charge would be 450,000. The IHT charge, his children would pay is 280,000. Total estate value = 1,150,000 Less available nil rate band = 450,000 Taxable estate = 700,000 Taxed at 40% = 280,000 Leaving 870,000 to be shared between the children. If the net value of the estate (after deducting any liabilities such as a mortgage, but before reliefs and exemptions) is above 2 million, the value of the residence nil rate band will be gradually tapered away by 1 for every 2 that the net value exceeds that amount. What happens if the nil rate band isn t used If any part of the nil rate or residence nil rate band isn t used when one partner (spouse or registered civil partner) dies it can be transferred to the estate of the second partner. Being able to transfer the nil rate band which wasn t used can reduce IHT for married couples and registered civil partners.

04 A guide to Inheritance Tax planning The legal personal representatives of the second spouse or civil partner to die have to claim the transfer of the unused nil rate band. The second person s nil rate band will increase by the percentage of the first person s unused nil rate band and/or residence nil rate band. So if the first person s nil rate band wasn t used at all then it will increase the second person s nil rate band/residence nil rate band by 100%. The following example shows how this works in relation to the ordinary nil rate band. Mr Smith dies in 1995 leaving his estate to his wife. None of Mr Smith s nil rate band was used as all his assets passed to his wife. Mrs Smith dies in May 2017. Her total estate is worth 600,000 and is left to nieces and nephews. When Mrs Smith dies the nil rate band is 325,000. As none of Mr Smith s nil rate band was used - 100% remains. So Mr Smith s unused nil rate band increases Mrs Smith s nil rate band by 100% - to 650,000. So no IHT needs to be paid. If Mr Smith s nil rate band hadn t been transferred then 110,000 IHT would have to be paid. This is the value of Mrs Smith s estate ( 600,000) less her nil rate band ( 325,000) = 275,000 x 40% = 110,000. Included in your estate Your estate is the market value of everything you own at the date of death. It includes assets you held in your name only and your share of assets you held jointly with someone else. The following are examples of assets that will be part of your estate. Your home and its contents Your car Jewellery Antiques Bank and building society accounts Investments (for example, shares) Your estate also includes the total value of certain gifts you have made: in the seven years before your death at any time if you continued to benefit from the gifted property (these are known as gifts with reservation of benefit ). Any money you owe, for example if you were paying a mortgage, and any funeral expenses will be taken from the value of your estate before the IHT is calculated provided those debts are settled out of your estate. How much IHT might need to be paid The following table shows the amount of IHT that might have to be paid on estates of different values. It does not take into account the effect of the residence nil rate band. Value of estate 325,000 None IHT payable 400,000 30,000 500,000 70,000 600,000 110,000 700,000 150,000 800,000 190,000 900,000 230,000 1,000,000 270,000 Despite the introduction of the residence nil rate band, the rise in house prices over recent years means more people will leave assets that take their estate over the nil rate band. This will reduce how much can be left to beneficiaries. Relief for business and agricultural property There may not be any IHT to pay on some types of business or agricultural property. The rules in these situations are complicated so please speak to your Financial Consultant. Leaving money to charity If you leave at least 10% of the net value of your estate to charity then your estate can benefit from a reduced rate of IHT of 36% subject to certain conditions. This only applies in relation to deaths on or after 6 April 2012.

05 The net value of the estate for this purpose is the value of the assets you leave when you die upon which IHT of 40% would otherwise have to be paid. To get the reduced rate of IHT, the total value of what you leave to charity must be 10% or more of the total value of your estate after the following items have been taken out: the liabilities of the estate any available nil rate band the value of assets passing to your spouse or registered civil partner any other IHT relief or exemptions, for example business or agricultural property relief. Who pays the IHT? When you die your legal representatives will deal with your estate and they will be liable to pay any IHT that is due. Normally the IHT must be paid within six months of your death. A grant of representation (which is issued by the court) is usually needed before your legal representatives can deal with your assets. However, the grant won t normally be issued until after the IHT has been paid. Therefore, although the IHT will reduce how much is passed to your beneficiaries, your legal representatives might need to use their own money or take out a short-term loan to pay the tax. In some cases IHT can be paid directly out of the deceased s bank accounts, but this is not always the case and if there aren t sufficient funds in the deceased s bank accounts to settle the liability, then an alternative source of funds will still need to be found. People will often set aside some money, held in trust, to pay any IHT. A trust arrangement means your money can be held outside of your estate and is available after your death without having to wait for the grant of representation. Making a will A will is an important document. It has all your instructions about who should receive your assets when you die. If you die without making a valid will, the law will decide who benefits from your estate. There are different rules for England and Wales, Northern Ireland and Scotland. It s important that your will is drafted correctly so that your wishes are met. You can leave your assets to specific beneficiaries as well as setting up one or more trusts to control money for the benefit of a number of beneficiaries. If your will passes all your assets to your wife, husband or registered civil partner then there won t normally be any IHT to pay. Making lifetime gifts Making gifts during your lifetime can reduce the amount of IHT which has to be paid. Lifetime gifts fall into one of the following three categories: exempt transfers chargeable lifetime transfers potentially exempt transfers. Exempt transfers There are various exemptions available that can be used to reduce the value of your estate. Some of these are explained below. Gifts between spouses or registered civil partners There is normally no IHT to pay on gifts made between a husband, wife or registered civil partners. This applies to gifts made during your lifetime or on your death. Annual gifts You can make a gift of up to 3000 in each tax year (the tax year runs from 6 April one year to 5 April the following year) and these gifts will be exempt from IHT. If you don t use all of the 3000 each year then you can carry it forward one tax year only. Regular payments out of your income If you regularly give money to someone from your income (pensions or earnings, for example), there won t be any IHT to pay on this money either at the point the gift is made or when you die. These payments will only qualify if you have enough income left to fund your normal lifestyle. Regular payments won t reduce the value of your estate but they can help stop the value increasing. Wedding gifts or civil partnership ceremony gifts You can make wedding or civil partnership ceremony gifts up to a certain amount free of IHT. For children you can gift them 5000, for grandchildren you can gift them 2500 and for anyone else you can gift them 1000. But you need to give this gift either on

06 A guide to Inheritance Tax planning or shortly before the wedding day or civil partnership ceremony. Also the marriage or civil partnership needs to actually take place. Small gifts You can give a small gift of up to 250 to as many different people as you like in any tax year without IHT having to be paid. However, you can t combine this with other exempt gifts like the annual gift or the wedding/civil partnership ceremony gift. Gifts to charities, political parties or national organisations You can give money to registered charities, political parties or national organisations (for example, museums or galleries) without paying any IHT. Chargeable lifetime transfers Chargeable lifetime transfers (CLTs) are gifts made into most types of trusts which exceed available exemptions. There will be no IHT to pay when making a CLT if the total amount of CLTs in the previous seven years is less than the available nil rate band. For this purpose, the residence nil rate band is not taken into account. However, if the CLT, when added to the total amount of CLTs in the previous seven years, is more than the nil rate band, there will be a lifetime charge to IHT of 20% (on the amount over the nil rate band). CLTs will usually fall outside of your estate for IHT purposes if you survive for at least seven years after the date the CLT was made. However, if you die within seven years of making the CLT then its value will be part of your estate. Any IHT you have already paid on a CLT when you were alive will be deducted from any IHT due on it after your death. IHT may also have to be paid: every 10 years on assets held in trusts (the periodic charge); when money leaves the trust (the exit charge). This applies if the value of the trust is more than the available nil rate band. IHT will be charged at 6% on the amount over the nil rate band. It is the trustees responsibility to pay this tax. There is more information about the IHT periodic and exit charges in our individual trust booklets. Please speak to your Financial Consultant for guidance. Potentially exempt transfers Potentially exempt transfers (PETs) are outright gifts to individuals as well as gifts into certain very specific types of trusts which exceed available exemptions. There is no IHT to pay straight away when you make the PET but IHT will need to be paid if you die within seven years and the PET is more than the nil rate band. If the PET is within the available ordinary nil rate band there will be no IHT to pay on the PET itself but if you die within seven years the PET will affect the value of your estate as it uses up some of the nil rate band. For example, you make a PET of 100,000. If you die within seven years of making the PET there may be 40,000 IHT to pay (40% of 100,000) if your estate is over the total available nil rate band. This is because there is 100,000 less of your nil rate band available to use against the rest of your estate. If you survive for more than seven years the PET wouldn t be part of your estate so up to 40,000 IHT would be saved. There is more information about the IHT charges in our absolute trust booklet. Please speak to your Financial Consultant for guidance. Things to consider before making lifetime gifts There are some important things you should consider before making any lifetime gifts. Can I afford it? If you gift money to an individual you won t be able to get it back in the future. If you set up a trust you can t break the trust just because you want your money back. You therefore need to decide how much you can afford to give as gifts and if you will need to access your money in the future. You can arrange trusts which give you access to your money but still save IHT. How much control will I have? If you gift money outright you will lose control of it. However, if you gift money into a trust, as a trustee you can control how and when the money is paid out. Therefore, if you are concerned about money being misused then placing it into the right trust might be the best approach.

07 What is a trust? A trust is a legal arrangement that you create. You give certain individuals (which can include yourself) the power to deal with assets for the benefits of others. Who sets up a trust Settlor this is the person who makes a gift into the trust. Trustees the trustees are the legal owners of the assets in the trust and they look after these assets for the beneficiaries. Beneficiaries the people who will eventually receive the assets in the trust. Why a trust is used A trust allows you to make gifts but still keep some control over who benefits from the money and when. It can also help you save IHT. We have a range of trusts to suit different circumstances. There is a summary of these below. There is more detailed information in our individual trust booklets. Please speak to your Financial Consultant for guidance. Types of trust Discretionary trust This type of trust lets you give the trustees wide discretionary powers over when and how the assets of the trust are used for the benefit of a broad range of beneficiaries. The trustees have powers to decide: Which beneficiary to make payments to What gets paid out How often payments are made Discretionary trusts are sometimes set up for children as you may not know which child will need more financial help in the future. These trusts are also sometimes set up for beneficiaries who are not responsible enough to deal with money themselves. Gifts into this type of trust are CLTs. Discounted gift trust A discounted gift trust lets you hold a lump sum into a trust for chosen beneficiaries, but you keep the right to having a regular income from the trust, during your lifetime. As you keep a right to payments, a discount is applied to calculate the amount you are giving away. This discount represents the total amount of your money which you are likely to receive based on the level of payments and your age and health. The balance between the discount and the total amount of money put into the trust is a CLT. This reduces the amount of the IHT as it is only the CLT which IHT has to be paid on. The rest (the discounted amount) is outside of your estate. You can use this type of trust if you can t afford to give away a lump sum entirely but you only need access to some of your money. Loan trust This is a flexible trust which you make an interestfree loan into. The loan has to be paid back when you ask for it. The loan is normally repaid in regular instalments. The outstanding loan is part of your estate when you die, but there is no IHT to pay on the growth on it. This type of trust can be used if you want to keep full access to your money but save IHT on the growth of the money. Absolute trust This type of trust can be used to hold money for children who will benefit when they get to age 18. What the beneficiaries are entitled to can t normally be changed. An absolute trust might be used if you know exactly who you want to benefit from the money placed in trust and are confident you won t need to change these beneficiaries in the future. Gifts into this type of trust are PETs. Next steps Each person s circumstances are different. Therefore getting professional advice is important. With access to a range of trusts and other products, our Financial Consultants can advise you on your IHT planning and help you put a strategy in place. The information in this leaflet is based on our understanding of the current law and HMRC practice. It assumes that you are a UK resident. The Wesleyan trust range is established under the law of England.

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