Inheritance Tax Planning -
it's never too soon to start

If you are resident and domiciled in the UK, your estate will be potentially subject to UK IHT on your death and certain gifts made during your lifetime may also attract an IHT charge. Using current rates, the first £312,000 of your estate will be charged at 0% (known as the nil rate band) and the balance at 40%. As a result, no matter what age you are, if the value of your estate exceeds £312,000, you could have an IHT ‘problem’. For a net estate worth £5million for a single person, the potential IHT charge on death is over £1.8million – effectively a third of the net estate going to the Treasury.

Despite the current market adjustments, more and more people are finding that, when their properties are aggregated with all their other assets, their estates are in excess of the nil rate band, meaning that IHT is no longer relevant just to the extremely wealthy.

IHT planning is about reducing this potential liability and there are various strategies to be considered, ranging from making use of the allowances available (for example, the annual gift allowance of £3,000), to taking out life insurance to provide a fund to pay the liability on death.

For those who have substantial incomes, it may be possible to give quite sizeable sums away tax efficiently. To the extent that you can prove to HMRC that you have income surplus to your needs, and you can establish a pattern of regularly gifting this surplus income, these gifts may be completely exempt from IHT.

Most gifts above the allowances are known as "Potentially Exempt Transfers" ("PETs"). In effect, this means the value of any unfettered gift above the annual allowance will only remain within the individual’s estate for IHT purposes for seven years following the gift.

However, tax should not be the only consideration and before making gifts, you must be certain that you will not need recourse to the asset given away or the income generated by the asset. You must also consider whether your proposed beneficiary is financially mature enough to deal with the gift. For example, where the gift is made to a child, you should satisfy yourself that the child can handle the asset being gifted. In addition, in the event that the child was to face a financial challenge - a divorce or business liability, for example - your gift could become a part of any settlement.

If, having considered these points you wish to make gifts from your estate but do not wish to put funds or assets absolutely into the hands of your intended beneficiaries immediately, then a trust may be the solution. By gifting funds to a trust, you are still able to retain some control and determine when distributions of either income or the underlying capital are made to your chosen beneficiaries. Any gift into trust will fall within the normal seven year rule provided its value does not exceed the value of the nil rate band. Consequently, at present, a husband and wife could potentially put up to £624,000 into trust without an immediate IHT charge.

Once the seven year period has passed, the nil rate band is "refreshed" and it may be possible to use it again to put further money into trust in a tax efficient way. Furthermore, for those who own qualifying businesses or agricultural property, there is also the potential to benefit from other exemptions which are currently exceptionally generous.

There are ways to reduce your exposure to IHT using UK charities. Gifts to UK charities are completely free of IHT and the seven year rule does not, therefore, apply. Such gifts can also have the added benefit of attracting some income tax and capital gains tax reliefs.

Wills

Tax is one reason to have a valid will in place but it is also important to prepare a will to ensure that your estate passes to whom you wish on your death.

If you have no will in place, the intestacy rules will apply, which could mean that those closest to you will not receive any benefit without the time and cost of applying to court, as well as having unintended IHT consequences.

For example, if you are married with children, your spouse does not automatically receive the whole estate but takes only £125,000 (increasing to £250,000 from 1 February 2009) together with an interest in half of the residue for life. The other half is held for the children on trust until they reach age 18. This can lead to difficulty when the marital home has been in the name of the deceased.

Furthermore, because dependants are not automatically recognised under the intestacy rules, a ‘partner’ from a co-habiting couple would not be automatically entitled to any share of their deceased partner’s assets. Under a worst case scenario, the surviving partner could end up without a place to live or needing to pursue an expensive and time-consuming claim through the courts.

According to research carried out by the Rowntree Foundation in 2005, only 23% of the population aged between ages 30-39 have made a will but at the opposite end of the spectrum, of those over the age of 80, 84% have made a will. Even at this level, however, many people will still die intestate.

In fact, we find that many of our young clients are motivated to put wills in place to ensure guardians are appointed in the unlikely event that they were to die at an early age.

In conclusion, from an IHT perspective, if your net estate is worth more than the nil rate band, you could have an IHT issue. There are various strategies which can be implemented to reduce the liability, and using your allowances along with making use of the seven year rule to remove assets from your estate is a step in the right direction. Coupled with a tax efficient will and regular review of your asset base, it is possible to significantly reduce your IHT exposure, particularly with the use of trust structures.

Remember - no matter how young you are, it’s never too early to start planning.