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The estate we&#39re in

The ease at which we all fall into the inheritance tax liability category is becoming only too obvious. House prices have risen dramatically over recent years. Gifting a house and still living in it may no longer qualify as a straightforward gift as even if the donor is paying a rent for the property it would be classified as a gift with reservation. The Finance Bill 2004 is clearly making it less attractive to embark on certain gifting plans and the new rules could mean someone could be liable for income tax on the benefit derived from gifts made up to 20 years ago.

Certain schemes such as discounted gifts currently appear to fall outside the legislation but, as the new rules are retrospective, this must cause concern for current and future participants in such schemes. What is needed is clarity.

If it is becoming more difficult to use complex trust arrangements to provide an income steam to the settlor the only other option is to actually gift and not retain any benefits or provide for the inheritance tax that would be due on death.

Looking at gifting with no benefits retained does not remove the potential tax liability immediately as this remains intact over a seven-year period. What is often overlooked during estate planning is the impact of the nil-rate IHT band as some, if not all, of the gifts may fall into this category for the first seven years. Gifts that fall within the IHT nil-rate band do not attract taper relief.

The current limits are:

IHT nil-rate band

£263,000

Annual exemption £3,000

Small gifts £250

Gifts on marriage by:

Parent £5,000

Grandparent £2,500

Great grandparent £2,500

Bride £2,500

Groom £2,500

Anyone else £1,000

Gifts from normal expenditure

Pattern of gifts required as proof

What about the potential effect of gifting over the subsequent seven-year period? The gift may originally fall into the nil-rate band but, if not, the decreasing levels are:

Years between gift and death

Percentage of full IHT liability 1-3 years 100%

3-4 years 80%

4-5 years 60%

5-6 years 40%

6-7 years 20%

Gifts to charities tend to be exempt from IHT.

One could say if a gift is made during the lifetime of the donor, then if it falls within the IHT nil-rate band but this does mean more of the remaining estate will be taxed at the then rate – currently 40 per cent. There are ways of providing for this tax however. Estate planning is acceptable, and often essential to preserve the property the donor has worked hard to accumulate.

Take an example: James Amos has decided to gift £100,000 to each of his two grandchildren in the form of a country cottage. He has had it valued at £200,000 and has documentation to prove this.

After making the decision to gift this cottage he has the deeds drawn up and the property passes into the name of his grandchildren.

James should not encounter the wrath of the New Finance Act or have any problems with gifts with reservation. He has no intention of going to the cottage again and he has made an outright gift. His worry now is that if he were to die within the seven-year period, his grandchildren would have to fund the IHT liability.

His financial adviser and solicitor suggest he considers taking out a gift inter vivos life insurance policy. He understands that the tax would have to be paid if he were to die within seven years of the gifts.

The total of the gifts that James has made is £463,000 this year. We can assume that the cottage was above his nil-rate band and, in view of this, his IHT liability on this gift would be a shown in the table at the bottom of this page.

To protect the whole of this gift during the seven-year period, the gift inter vivos plan covering the full liability of £80,000 (in year one), would be placed in trust and for the benefit of his grandchildren.If James should die during the lifetime of the policy, the proceeds would be paid outside his estate.

James is 50 years old and is a non-smoker. According to The Exchange, there are not many providers offering gift inter vivos plans. Liverpool Victoria and Lutine have plans specifically for gift inter vivos while Scottish Equitable and Standard Life appear to include it in some of their policies.

Having decided that he would like to consider the option of covering his IHT liability, he needs to look at the cost. Liverpool Victoria&#39s gift inter vivos policy for seven years would cost £13.28 a month or £152.91 a year or £993.34 single premium. The monthly or annual charges could be classified as gifts out of normal expenditure and be exempt from further IHT charges. The single premium could be classified as a gift as part of James&#39 annual exemption and no further IHT charges apply. If James decided to take the single premium route, for just under 1.25 per cent, he could cover 100 per cent of the IHT liability.

Estate planning is an area where financial advisers can add value and should form part of an annual review, given the speculation that changes are afoot over the way that IHT will be charged in the future.

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