As we get older and we are more financially secure it is only natural that we consider the future for our children and grandchildren.
However, the situation is brought into sharper focus by the fact that UK Inheritance Tax (IHT) may well reduce the amount that we are able to leave to our grandchildren.
IHT is a tax levied against the value of an individuals estate on death and also, in some circumstances, on gifts made during their lifetime.
Inheritance Tax: An individual is allowed to leave only £325,000 to his or her heirs without the estate suffering IHT. This amount is referred to as the nil rate band. A married couple and registered civil partners are allowed to leave twice this amount between them and, with the appropriate planning, only an amount of over £650,000 should suffer IHT.
IHT legislation allows individuals and couples to make gifts during their lifetimes to reduce the value of their estate on death. These lifetime gifts are known as potentially exempt transfers (PETs) or chargeable lifetime transfers (CLTs) and, providing that the donor survives seven years after making the gift, the amount gifted will not be liable to the 40% IHT charge.
Where the donor does not survive seven years, the value of the gift is liable to IHT.
For larger gifts that are above the nil rate band a further relief known as taper relief, may also apply reducing the amount of IHT that will be payable. Taper relief applies from three years after making a gift.
So, for example, you can make a large gift to your children and this will reduce your IHT liability but it does mean that you lose all future access to the assets gifted. Most people, therefore, will be reluctant to make gifts that may result in themselves, or their partner, having insufficient funds in the future. In particular, there is a concern with most people that, as they get older, they may need to retain funds to meet the cost of long term nursing home care.
A solution to this problem lies within anwritten via a special double trust arrangement and allows you to:
Make a gift to your chosen beneficiaries, and:
- To receive a yearly ‘income’ if needed
This type of arrangement provides you with the opportunity to reduce your potential IHT liability and maintain your peace of mind that you will not be forfeiting your financial security in exchange for saving IHT. This is of particular importance at the present time given our ability to live longer and the need to adapt to changing circumstances.
How much should you gift?
When you make a gift into this type of arrangement, it is known as a CLT for IHT purposes. Any amount gifted that is above the IHT nil rate band (£325,000) will cause an immediate IHT charge. This will be charged at the lifetime IHT rate of 20%. For this reason, it is suggested that the amount gifted into this type of plan should be within the available nil rate band. This assumes that you have not made any other CLT’s in the last seven years.
After seven years the amount of the gift will be outside of your estate for IHT purposes. On a gift of £325,000 this could mean a reduction in your IHT bill of £130,000. It is worth remembering that if you live for seven years after making the gift you will be eligible to use the nil rate band again against the remainder of your estate.
Summary of benefits:
This type of trust and IHT planning offers many benefits including:
A yearly ‘income’, which can be taken in full, in part or deferred to any future anniversary.
- The capital is outside of your estate for IHT purposes after seven years (that is, for the 40% inheritance tax calculations).
- By investing in the trust, the value of the gift is frozen for IHT purposes but you can still benefit from any increases in the stock market performance of your chosen funds.
- You have access to a wide range of well known fund managers and funds
When it comes to tax planning and, especially when planning for inheritance tax, the advice would seem to be: the sooner you start the greater the chance of reducing the effects of IHT and therefore the greater the chance of passing wealth intact to your children and/or grandchildren.