Defaqto

Do non-married couples benefit?

No, the reforms only apply to legally married couples and registered civil partnerships. However, non married couples can still use their individual £325,000 allowances (2008-09) to bequeath assets to each other and their heirs, but only if they have sufficient assets to do so.

My spouse died before 9 October 2007 and I haven’t remarried. Do I benefit from these changes?

Yes, the legislation is retrospective. However long ago your spouse died, you should be able to use both allowances. There will be special rules, yet to be published, for deaths prior to 21 March 1972.

The individual allowances for both spouses are those which are applicable in the tax year of the second death. For example, if your spouse used only half of their allowance for the year in which he or she died (for example, only £45,000 of the £90,000 IHT allowance for 1987-88 was used),  the remaining 50 per cent can be mopped up in the tax year of your (the second|) death and added to your own exemption.

I already have a will trust in place to make use of both allowances. Should I change it?

This is probably a nil rate band discretionary trust, which was set up when you wrote your wills, on the advice of a solicitor.. If you and your spouse are both still alive, the trust will not have been created as these trusts only become effective on the death of the first spouse.

If the purpose of the trust was simply to use both spouses’ nil rate bands, it is of no great use now and it may be cheaper to redraft your will to remove the trust, as it will be incurring annual management fees to keep it running.

Alternatively, your executors may be able to collapse it without the need to redraft your will.

I have a will trust in place because I want my children and grandchildren to benefit from my estate. Should I do anything?

Trusts can still be useful if you want to pass assets to children and grandchildren at a particular time, and in a particular way. For instance, if you are bequeathing assets to children, you may wish to set down conditions, such as the assets not passing to the child until a certain age, or on  marriage.

For very large estates, the settlor may wish to ensure that the estate is managed on behalf of a surviving spouse.

My husband, who died some time ago, set up a discretionary will trust before his death. What are the implications for me and the other beneficiaries?

There is usually little you can do to alter the terms of such a trust, particularly if the beneficiaries are yourself and the children from a previous marriage. You could ask the trustees for advice, but the new rules are unlikely to help in this case.

Ian Miles, an IHT specialist at accountants, Grant Thornton: “This is a complex area and each case should be judged on its own merits.”

What other ways can I avoid IHT?

Make a will

Your starting point always should be to write a will and review it every few years to check that it still reflects your wishes and dovetails with prevailing tax legislation. Failure to review your will, or to write one at all, could result in your estate passing to the wrong people.

Why a will is essential

It allows you to:

• direct who receives your assets – in the absence of a valid will, the intestacy rules dictate what your spouse/civil partner and wider family receive;
• pass your estate to someone other than a spouse or civil partner who might otherwise inherit everything under the current intestacy rules;
• decide how much to leave to different individuals;
• state whom you wish to be the guardians of your children;
• make IHT-free legacies to charities and national institutions; and
• bequeath individual possessions to a close friend or family member           

A will can also serve as a tax mitigation tool, so don’t be one of the estimated 50 per cent of the UK adult population over age 45 who have failed to write one.

Divorce, or dissolution of a civil partnership, could cause parts of your will to be nullified and marriage may completely invalidate your current will. Also if you change an existing will, it is generally a good idea to start the new one with a clause stating that it ‘revokes all previous wills.’

Exempt transfers

Exempt transfers (see list below) allow you to gift various amounts to different types of beneficiary each year with no IHT liability, although all such gifts should be recorded.

‘Gifts out of surplus income’ can be exempt, but should be treated with particular care and recorded, as they must be:

• regular payments from your income, and
• not have a detrimental effect on your normal standard of living.

Other transfers which are exempt from IHT

• all transfers between UK domiciled spouses/civil partners (but only £55,000 if  your spouse is non-UK domiciled);
• gifts to charities and political parties;
• gifts to national institutions (eg National Trust, British Museum);
• gifts for maintenance of the family;
• regular gifts out of surplus income (which do not affect your standard of living);
• small gifts of up £250 pa to any number of individuals;
• £3,000 pa to any individual/s (eg £1,000 to each of three children, or £3,000 to one child).

This exemption can be rolled over for one tax year, but cannot be combined with small gifts

• £5,000 gifts from each parent to a child on marriage/civil partnership
• £2,500 gift from each grandparent (or remoter ancestor), to a grandchild on marriage/civil partnership, or from one party to the marriage to the other;

Potentially exempt transfers (PETS)

For other gifts, which do not fall within the ‘annual gift exemptions’ listed above, unlimited direct gifts can be made during your lifetime to any individual. These will be treated as ‘potentially exempt transfers’ or PETs and you must survive seven years from the date of making the gift for it to be free of IHT.

If you die within the seven years, the IHT is calculated on a sliding scale, known as taper relief (see below), ranging from 40 pc in the first three years, to 8pc in the seventh year, on any excess over the nil rate band.

Taper relief (IHT charged if you die within 7 years of making a gift):               

• 1-3 years @ 40 pc (full rate: 40 pc)
• 3-4 years @ 32 pc (20 pc taper relief)
• 4-5 years @24 pc (40 pc taper relief)
• 5-6 years @ 16 pc (60 pc taper relief)
• 6-7 years @ 8 pc (80 pc taper relief

Gifts with reservation

In order for a gift to be effective for exemption from IHT, the person receiving the gift must get the full benefit of the gift to the total exclusion of the donor.

Otherwise, the gift is not a gift for IHT purposes. For example, if you give your house to your children, but continue to live there, without paying a market rent, then the house remains in your estate for IHT.

Decreasing term assurance

Decreasing term assurance can be arranged to cover the potential IHT liability during the seven year period following potentially exempt gifts.

Such policies should be written in trust, so that the proceeds fall outside your estate and can be paid quickly to your beneficiaries when you die to pay the necessary tax.

Business and agricultural property

These are both exempt from IHT.

Aim shares

AIM shares, or shares qualifying as ‘business property investments’ in certain AIM-trading companies, or unquoted trading companies, can attract 100 per cent relief from IHT, provided that:

• the investment is held for at least two years; or
•  before a chargeable transfer for IHT purposes takes place (such as a transfer to a trust), and  they are still held by the transferee at the death of the donor, if within seven years.                       

Settling business property or agricultural property on trust could save the 20 per cent set-up charge on trusts (see later) and, with careful planning, AIM shares could also be used to avoid the 10 year anniversary charges on trusts.

Woodlands

Woodlands may be exempt from IHT, as commercial woodlands are from income and capital gains taxes.

Pre-Owned Assets Tax

The Pre-Owned Assets Tax (POAT), which came into effect on 6 April 2005, clamped down on arrangements, typically involving houses with parents gifting properties to their children or other family members, while continuing to live in them without paying a full market rent. These arrangements were carried out in such a way as to ensure that they were not caught by the Gift with Reservation rules.

POAT is an annual income tax charge of up to 40pc on the benefit to someone, typically continuing to live in a property, which they have gifted, but without paying a full rent, where the arrangement is not caught by the Gift with Reservation rules.

So anyone who has effected such a scheme since March 1986 and which falls within the POAT net, could be liable to an income tax charge of up to 40pc of the annual market rental value of the property, unless they elect by 31 January following the end of the tax year in which the benefit first arises, that the property remains in their estate.

Rental valuations of the property must be carried out every five years by an independent valuer.

Those doing equity release schemes are exempt from POAT, as are those whose home has an annual rental value below £5,000 (for a sole occupant) or £10,000 (for a couple).

Gifting property to an adult child

If you wish to gift property to an adult child via a trust, (under the rules applying since 22 March 2006), you can elect to hold over the capital gains tax liability. Otherwise, CGT would be payable on such a transfer because it is effectively a gift of the property. However, no private residence relief will be available on a future sale.

Use of trusts in IHT planning

A financial adviser will often suggest using a trust to preserve family wealth. A trust is basically an obligation binding a person called a trustee to deal with ‘property’ (assets) in a particular way for the benefit of one or more 'beneficiaries.'

There are several terms regularly used when talking about trusts:

• Trust property - this can include money, investments, land or buildings and other assets.

The cash and investments held in the trust are also called the 'capital' or 'fund' of the trust. This capital may produce income, such as interest or dividends. Land and buildings may produce rental income.

• Settlor – the settlor creates the trust and puts property into it at the start or later on. The settlor states in the trust deed how the trust's property and income should be used.
•  Trustees - trustees are the 'legal owners' of the trust property and must deal with it in the way set out in the trust deed.
• Beneficiary/ies – this is the individual/s who benefit from the property held in the trust, such as named individuals or the settlor’s family. Different beneficiaries can benefit from the trust in different ways, i.e. from the income only, the capital only, or both.

A trust might be created in the following circumstances:

• when someone is too young to handle their affairs;
• when someone can't handle their affairs because they're incapacitated;
• to pass on money or property while you're still alive;
• under the terms of a will;
• when someone dies without leaving a will (intestate)

Different types of trust

When writing a will, there are several kinds of trust that can be used to help minimise IHT liability. The Government changed some of the rules regarding trusts, which took effect from 22 March 2006 and introduced some transitional rules for trusts set up before this date.

Bare trusts

A bare trust is one where the beneficiaries are named and cannot be changed.

You can gift assets to a child via a bare trust, which will be treated as a Potentially Exempt Transfer (PET) until the child reaches age 18, (the age of majority in England and Wales), when the child can legally demand his or her share of the trust fund from the trustees.

All income arising within a bare trust in excess of £100 pa will be treated as belonging to the parents (assuming that the gift was made by the parents).

But providing the settlor survives seven years from the date of placing the assets in the trust, the assets can pass IHT-free to a child at age 18.

Life interest or ‘interest-in-possession’ trusts’

With these trusts, the beneficiary/ies (sometimes called the life tenant/s) have a legal right to all the trust’s income (after tax and expenses), but not to the property of the trust.

These trusts are typically used to leave income arising from the trust to a surviving spouse for the rest of his or her life. On his or her death, the trust property reverts to other beneficiaries, (known as the remaindermen), who are often the children from a first marriage

With a life interest trust, the trustees often have a ‘power of appointment’ which means they can appoint capital to the beneficiaries, (who can be from within a widely defined class, such as the settlor’s extended family), as and when they see fit.

Where an interest in possession in this type of trust was in existence before 22 March 2006, the underlying capital is treated as belonging to the beneficiary/ies for IHT purposes, ie it has to be included as part of their estate.

Transfers into interest in possession trusts on, or after, 22 March 2006 are taxable as follows:

• 20 per cent tax payable based on the amount gifted into the trust at the outset, which is in excess of the prevailing nil rate band;
• 10 years after the trust was created, and on each subsequent 10 year anniversary, a periodic charge, currently 6 per cent, applied to the portion of the trust assets, that is in excess of the prevailing nil rate band.
• The value of the available ‘nil rate band’ on each 10 year anniversary may be reduced, for instance, by the initial amount of any new gifts put into the trust within 7 years of its creation.
• An exit charge on any distribution of trust assets between each 10 year anniversary.

The charge is based on the following:

• the length of time between the distribution of assets and the most recent 10 year anniversary;
• the value of the assets being distributed; and
• the effective rate of tax applied to the trust at the most recent 10 year anniversary.

If no tax was due at the most recent 10 year anniversary, then no tax will be due under the proportionate exit charge. In addition, if the trust has business or agricultural property, then the IHT reliefs for these types of property can reduce or eliminate the IHT charges.

Transitional rules apply to trusts established before 22 March 2006, so that in certain cases, for a new life tenant, the previous IHT treatment continues so that the trust funds are treated as belonging to the beneficiary/ies for IHT purposes.

WARNING!

Calculating the 10 year anniversary charge and the proportionate exit charges are extremely complex, and you are advised to seek professional advice.

Discretionary trusts

With a discretionary trust, the trustees decide how much income or capital, if any, to pay to each of the beneficiaries – although no beneficiary has an automatic right to either. The trust can have a widely defined class of beneficiaries – typically the settlor’s extended family.

Discretionary trusts are a useful way to pass on property while the settlor is still alive and allows the settlor to keep some control over it through the terms of the trust deed.

The charges which apply are the same as those set out above under interest-in-possession trusts. If the trust property is qualifying business or agricultural property, there is no IHT liability on these assets at the 10 year charge or at exits.

Discretionary trusts are often used to gift assets to grandchildren, as the flexible nature of these trusts allows the settlor to wait and see how they turn out before making outright gifts.

Discretionary trusts also allow for changes in circumstances, such as divorce, re-marriage and the arrival of children and step children after the establishment of the trust.

When any discretionary trust is wound up, an exit charge is payable of up to 6 per cent of the value of the remaining assets in the trust, subject to the reliefs for business and agricultural property.

Accumulation & Maintenance trusts

Accumulation and Maintenance (A&M) trusts which were already established before 22 March 2006, and where the child is not entitled to access to the trust property until an age up to 25, could be liable to an IHT charge of up to 4.2pc of the value of the trust assets.

It has not been possible to create an A&M trust since 22 March 2006, for IHT purposes. Instead, they are taxed to IHT as discretionary trusts.

Trusts for vulnerable persons

These are special trusts, often discretionary trusts, arranged for a beneficiary who is mentally or physically disabled. However, they do not suffer from the IHT rules applicable to standard discretionary trusts and can be used without affecting entitlement to state benefits. Strict rules apply, so professional advice is essential.

Whole of life assurance

If, despite all your planning, you believe that there will remain an IHT liability on your death, you can buy a purchased life annuity (out of your savings) and use the income to pay regular premiums towards a term, or whole of life, assurance policy.

This is known as a ‘back to back’ arrangement. Alternatively, you could simply pay the premiums as and when they are due out of your savings. A whole of life assurance policy should be written in trust so that it falls outside your estate and the proceeds can be paid quickly to your beneficiaries when you die.