I live in a house which is valued well in excess of the nil-rate band for inheritance tax as well as holding other assets. Do you have any advice on my options regarding inheritance tax?
Your situation is not uncommon as it is estimated that one in three houses are now valued at over the nil-rate band of 285,000 for 2006/07.
There are ways in which inheritance tax liabilities can be reduced which effectively involve making a gift of capital and/or income in one form or another. However, many people find that their house is their only asset and they need all their income so they have little room for making gifts.
In the past, it was possible to make gifts into trusts so that after seven years the capital was outside your estate for inheritance tax purposes and the beneficiaries received the capital at a date decided upon by you, either at outset or later.
However, proposals in this year’s Budget made these trusts less attractive by:
Imposing a tax charge of 20 per cent upon setting up the trust.
Charging 6 per cent of the value of the trust every 10 years.
Imposing a proportionate exit charge when capital leaves the trust between 10-year anniversaries.
In addition, the potentially-exempt transfer is now known as a chargeable lifetime transfer.
These proposals have now been formally approved by the passing of the Finance (No 2) Bill 2006. However, it seems that only gifts that are in excess of 285,000 will suffer the 20 per cent charge and that the 6 per cent charge will be applied only to trust assets over the then nil-rate band.
What this means is that gifts below the nil-rate band can be put into a flexible trusts without the 20 per cent tax charge and the 6 per cent charge will only apply every 10 years on the trust’s assets which exceed the then nil-rate band. It should be noted that these tax charges do not apply to absolute trusts.
The Government says it is only the very rich who will be affected but many people who are not so very rich may have to rewrite their wills at an obvious cost.
Returning to the subject of gifts in general being used as a way of passing on assets and thus reducing the value of one’s estate, some people find they cannot afford to gift away capital as they lose the right to benefit from it, especially if they need income. However, there are plans whereby capital can be gifted and an income from the capital can still be retained by the donor. In this way, the capital and any growth will be outside the donor’s estate but the donor will still receive an income. If capital can be released from the donor’s property and placed into such a plan then:
The inheritance tax liability is reduced.
The donor’s income is increased.
Of course, trusts are not the only way to reduce your liability for inheritance tax. Other means are by gifting away capital directly to others such as children or grandchildren. Small gifts of up to 250 can be made to any number of people in the same tax year. The gift must be outright and it cannot be made via a trust.
As soon as the total gifts made in the tax year to the same person are more than 250, this exemption cannot be used against those gifts. A one-off gift of 3,000 can also be made each tax year.
It is also possible to give money in consideration of marriage or civil partnership. Each parent can give 5,000 to a child, each grandparent can give 2,500 and any other person can give 1,000. But it is important to note that this cannot be used in conjunction with any of the other gift exemptions. It is also possible to transfer assets between spouses and civil partners on a tax-exempt basis as long as they are UK domiciled, otherwise a limit of 55,000 applies.
Careful will planning is essential, remembering that your total assets, onshore and offshore, are assessed for inheritance tax purposes. A solicitor’s advice should be sought. Indeed, your will and any existing trust arrangements should be reviewed in light of the Finance Bill, with any alterations made before April 6, 2008.
Lisanne Mealing is a director at MDM Associates