Alive and kicking

Kevin Dean highlights the importance of carrying out thorough inheritance tax planning

Despite changes in the Finance Act 2008 and the possibility of the inheritance tax threshold changing after a general election, inheritance tax (IHT), while being a tax on death, is still alive and kicking.

In the Finance Act 2008, HM Revenue & Customs (HMRC) announced new legislation to change the way IHT is charged under certain circumstances. This change applies to married couples, or those that have entered a civil partnership.

The change means that any unused nil rate band (the amount exempt from inheritance tax) of the first spouse, or civil partner, to die could be passed to the surviving spouse on their death.

Furthermore, if that person had survived more than one spouse, they could receive their available nil rate band as well, providing this did not exceed 100% of the nil rate band on their subsequent death.

Under the IHT legislation, spouses or civil partners that are UK domiciled are entitled to transfer their assets, and in particular property, to their spouse/civil partner free of IHT. For this reason, in the past many people have simply written wills that allow their partners to receive all their assets. They had not utilised their nil rate band as the value of their assets at the time simply didn’t warrant any inheritance tax planning.

In the early 1990s, just before the housing boom that hit the UK, house prices were moderate and the average UK resident may not have considered IHT planning on their death, or that of their spouse. The rise in property prices in the 1990s quickly outstripped the growth in the amount of the nil rate band. The result was a growing number of estates becoming liable to IHT on death.

One reason for the introduction of the transferable nil rate band was to counter the increasing number of widowed people being caught by IHT. This is because their spouse had left their share of the house to them and the value of the house had increased over and above increases to the nil rate band amount.

Making gifts during lifetime, perhaps utilising trusts, can still be an effective means of reducing the potential IHT liability on death. A gift into trust will be treated as either a chargeable transfer or a potentially exempt transfer depending on the trust used. Broadly speaking, such a gift will drop out of the client’s estate once they have survived seven years from the date of the gift. This allows clients to reduce their estate during lifetime but enables these monies to be potentially managed in accordance to their wishes. By using this type of planning during lifetime, clients may be able retain their full nil rate band on death.

Effective will planning

The use of effective will planning can also create trusts on death, making use of the available nil rate band, and enabling trustees to decide who receives the assets of the deceased, and when.

This also avoids the requirement for the executors of the surviving spouse to claim the transferable nil rate band of the first spouse, thus relieving them of the task of obtaining the information necessary to complete the IHT402 form.

Another option might be loan trust schemes, which provide a mechanism to make sure any investment growth is kept outside the transferor’s estate, but enable the settlor to have access to their capital. Discounted gift trust schemes allow for IHT planning by providing a discount to the gift which is based on a retained income stream selected by the client. Discounted gift schemes are ideally suited to people who have perhaps left their planning opportunities until later in life. They still may wish to make gifts and are comfortable with losing access to their capital but require an income from the capital gifted.

Assuming that person receives a discount, the discounted gift trust allows for an immediate reduction to the client’s estate even if they should not survive the seven years.

It is clear that IHT requires a great deal of planning and advice should be sought. Regardless of what happens at the next general election – the need for planning lives on!

Kevin Dean is CEO of AXA Wealth International