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Exemptions to the rule

Julie Hutchison, head of estate planning at Standard Life, sets out how to minimise inheritance tax

First, a reminder about the level at which IHT starts to bite. The nil-rate band is £325,000 and has been set at that level for the next four years ahead, in theory. That could change but that is the default position for the foreseeable future.

On death, the rate of 40 per cent applies above that level, unless one of the many exemptions applies, more about which later.

IHT is one of the taxes where marriage/civil partnership is treated beneficially. This is found with the transferable nilrate band, where the unused nil-rate band of the first to die can be used when the survivor dies. Any IHT planning for clients needs to keep this in mind, in particular where a widow(er) remarries, you could find that the married couple or civil partners in front of you have £1.3m of estate which will be unaffected by IHT as a result.

A further example of the way that marriage/civil partnership is rewarded in the tax system relates to the exemption for gifts in consideration of marriage/ civil partnership. There are three different amounts involved in that exemption, which depend on the relationship between donor and donee.

As well as being a tax on death, IHT can be a lifetime tax at the rate of 20 per cent although many people keep their gifting to certain types of trust within the nil-rate band limit to avoid that charge.

The variety of exemptions that exist are worth making the most of with clients. In addition to the important spouse/civil partner exemp-tion, the simplest exemption to use is the annual exemption of £3,000 which can be carried forward for one year only to become £6,000.

There is also the exemption for charities, which was expanded recently to allow European charities to enjoy similar tax treatment as UK charities. Many charities benefit from legacies under wills, or from lifetime gifts, both of which can be free of IHT with this exemption.

When discussing lifetime gifts with clients, the focus is often on capital and the extent to which it is required or can be gifted. A second type of gift, and perhaps more important when it comes to IHT exemptions, is the exemption for regular gifts from surplus income.

This is a fantastic exemption which is judged according to the patterns and habits of the individual. The criteria are :
1: That the gift is from income (not capital)
2: That the gift forms part of a pattern
3: That the client can maintain their usual standard of living from income after making the gift.

Evidence and paperwork are important here. The benchmark for what HM Revenue & Customs will require is the form which is used to report these income gifts when the client dies. It can be obtained from www.hmrc.gov.uk and the relevant form is IHT403.

When dealing with clients who are retired, the income gift option is worth explor-ing in the same conversation about income needs and pension withdrawals.

One of the leading court cases in this area, McDowell, dealt with just such a scen-ario where an elderly man was in receipt of a good pension and virtually all his daily living costs were paid for through care home fees. It was therefore straight-forward to show evidence of the surplus involved and that the standard of living of Mr McDowell was not in any way undermined by the gifts.

As well as being a tax on death, IHT can be a lifetime tax at the rate of 20%

The case was, however, a salient reminder to take care when dealing with powers of attorney and to be aware of the restricted gift-making powers available.

In England, court approval would generally be required for such gifts. In Scotland, income gifts can be made as long as the power to make gifts is specified in the power of attorney document.

Some clients will, however, want to retain and enjoy their assets and not make lifetime gifts. Where this does leave a significant IHT bill for the future, an option is to consider a life policy held in trust in order to fund the IHT liability.

This can ensure that assets do not have to be sold to pay an IHT liability on death and can form part of a strategy to preserve specific assets /landed property within a family.

A further point to check relates to a client’s pension provision and any death benefits arising. Some older pension contracts, such as retirement annuity contracts and section 32 bonds, have death benefits which are paid to the deceased client’s estate. This is not a helpful result in terms of IHT or asset protection for the wider family.

It is worth considering a trust to hold such death benefits although particular care is required if the client is in serious ill health, as the use of the trust in such a case could bring with it certain negative IHT consequences.

IHT is a complex topic and dabbling is dangerous. To get further support on IHT, one route would be to explore the new Step Certificate for Financial Services (trusts and estate planning), which I edited and co-wrote. This qualification, see www.step.org/pd, can support your professional development in this area.

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