IHT opportunities

Andy Kirby looks at the opportunities current markets present when it comes to inheritance tax planning

Far from being in decline in the falling market, we have seen a marked increase in IFAs looking to take advantage of depressed asset values to consolidate inheritance tax (IHT) valuations.

It may seem slightly perverse as many, indeed most of us, are still in a state of shock at how much our assets have fallen since the perfect storm began almost two years ago. My conservative calculations show that almost £1 billion has been wiped from the values of those deceased estates in the intervening period. With the FTSE fallen 40% and property prices fallen 15%, many beneficiaries are already counting the cost.

While I am not glib enough to pronounce that every cloud has a silver lining, the opportunity to sort out a client's IHT affairs before the market bounces, or even makes a sedentary crawl back, should not be overlooked.

One way to consider the position is that because gifts from potentially taxable estates are frozen in value at the time of gift, then all recovery growth is outside of the estate and free from IHT. If the client survives the gift by the usual seven year period then the principal value also escapes any charge to tax on death.

My experience as a tax adviser is that IHT is probably the most disliked tax, but equally the one most people are reluctant to tackle, despite the obvious financial benefits. IFAs are often the most critical link in terms of getting a client to take the leap of faith and consult a tax expert. It comes back to the basic principle that a joint professional approach often produces the best result for the client.

Less complexity

Over the last decade IHT planning has, on the whole, become less complex. However, most people fail to make a will and those that do, fail to update it. Those making IHT provision, invariably fail to update this too. The complication with this is therefore unwinding what is already in place.

With the significant number of changes introduced by the current government in relation to the taxation of trusts, a significant number of clients may no longer be up to speed on the tax consequences of arrangements put in place under their wills, particularly where sums are to be held for children or grandchildren on reaching a specified age.

Despite greater awareness, most clients still make basic errors when considering their tax arrangements. My experience shows that most of the mistakes that invalidate the IHT plans are made with property, whether it is the primary home or other property.

As readers will appreciate, when gifting property, one cannot give it away and continue to live in it and still avoid IHT, because HMRC deems that a benefit has been reserved. However, what many people fail to appreciate is that paying rent to live in a property is a very viable option.

With the falling property prices and similar rental costs this now makes this option much more worthy of consideration, particularly by those with a reasonable pension income. Firstly, assuming seven year survival, the home is IHT free. Secondly, the rent goes to the beneficiaries. This may have an income tax implication, but if it is being passed to non-tax payers the tax savings are dramatic.

A similar approach should be taken for second homes, whether in the UK or abroad. In fact, the advantages are often much more apparent and the emotional impact much less. Firstly, 'rent' is only payable to your beneficiaries for the time spent in the property. Therefore, a £250,000 flat on the Costas that is used for six weeks a year may be a few thousand a year, let us say £6,000 assuming a high season weekly rent, so after seven years the cost would be £42,000. For simplicity let us again assume no property inflation - which in many markets is a distinct possibility, the IHT saving is now £58,000 and, as importantly, you have made a legitimate and, IHT-gifting-rules-exempt, payment of £42,000 to the beneficiaries.

Even after death, there is some opportunity to mitigate IHT with property in the hands of the executors. Since HMRC rules allow trustees to use the sale value of a home for its value at death, providing it is sold within three years, low property prices can mean this is lower than the value at death.

Other options

If selling the property in the current market won't realise a reasonable value, a HMRC 10-year instalment plan could be considered, with one-tenth of the tax paid before probate and the remaining instalments on the anniversary of death. Interest is charged, currently, at 1% per annum.

Another point to consider is gifting. While gifting for the purposes of IHT mitigation is not something that everyone can afford, for those who can, there are no hard and fast rules as to how much to gift and it is important to consider the impact on the standard of living.

Similar principles apply to share portfolios and other assets with the ability to capitalise the values at one of the lowest levels for over a decade. To put this in perspective, consider a portfolio worth £500,000 in 2007 - this may well be worth just £400,000 today, so by giving it away today, a potential £44,800 could be saved in IHT, assuming the value recovers to its original point. This is enough to fund a grandchild at a top boarding school for almost two years and is certainly more than enough to fund them through their university education or even help with a deposit on a house.

There are other more affordable methods of gifting without any of it counting towards the estate. For example, £5,000 can be given in wedding gifts to a child and £2,500 for grandchildren. The revenue also kindly allows a £3,000 a year gift, whether this is to one person or split between three, and even regular gifts out of your income can be arranged which could be exempt from IHT.

Clearly, mitigating IHT is a long-term strategy and requires intricate planning. It is, however, important not to underestimate how much of your clients' money can be saved by effective tax planning.