INHERITANCE TAX PLANNING

HOW MUCH INHERITANCE TAX (IHT)?

Currently £255,000 is the threshold above which tax is payable. The value of assets above £255,000 is charged at the rate of 40%. If your estate is worth £355,000 then £255,000 of this is exempt and the balance of £100,000 is charged at 40% i.e. £40,000.

In a married couple each is able to give away £255,000 free of tax however full use of this nil rate band is often not made because each spouses leaves his/her whole estate to the other. On the death of the first spouse no tax is payable however, on the death of the second only £255,000 is exempt.

Here are two examples showing how inheritance tax bill can be reduced significantly.

Example 1 Discretionary Will Trust.

Consider the example of Mr and Mrs Jones. They have a home worth £400,000. They also have savings, policies, investments and other assets totalling £125,000 each. The joint estate is therefore worth £650,000; each having £325,000.

When Mr Jones dies he passes his £325,000 estate to Mrs Jones thereby making her total assets worth £650,000. On Mrs Jone's death her estate passes to the children. £255,000 will be tax free and the balance of £395,000 will be taxed at 40% i.e. £158,000! The children would ultimately have received £492,000 out of their parent's estate.

The reason that tax was payable is because Mr Jones was not able to utilise his nil rate band of £255,000.

This could have been done if Mr Jones had gifted the amount of the nil rate band to a discretionary will trust. Under this type of arrangement the Trustees would manage the assets and have power to pay income and/or capital to all or any of the class of beneficiaries. The beneficiaries would normally be spouse, children, grandchildren and their spouses, widows and widowers. Mrs Jones would be the primary beneficiary during her lifetime. Mrs Jones can access income and capital as required but to the extent that she has not required part of the trust fund then that part will not be treated as belonging to her for IHT purposes and will not therefore be taxable.

Mrs Jones will have an element of control over what happens to the trust assets by being appointed as one of the trustees.

If Mr Jones had created a discretionary will trust ( for sum up to the nil rate band) the affect on the above scenario would be as follows: -

1. On his death £255,000 will pass to the discretionary trust fund. The balance of £70,000 would pass to Mrs Jones. No tax is payable at this stage since the £255,000 is in the nil rate band and the balance of£70,000 is covered by the spouse exemption.

2. On Mrs Jones death, her assets will compromise £325,000 of her own personal assets plus the £70,000 left by Mr Jones, making a total of £395,000. Out of this £255,00 is tax free and the balance of £140,000 is taxable at 40% i.e. £56,000.

3. The children would therefore have inherited £395,000 less £56,000 tax totalling £339,000 from Mrs Jones estate. In addition they also had £255,000 from Mr Jone's estate which was held in the discretionary.

4. The total amount inherited by the children was therefore £594,000 (£225,000 plus £339,000) This compares with £492,000 that the children would have received had there been no discretionary will trust.

5. The total tax paid by the children was £56,000 instead of £158,000 saving £102,000!

Example 2 - Division of the assets

Mr and Mrs Smith have £50,000 in savings each and jointly own a property worth £300,000. Their joint estate is worth £400,000.

The home is jointly owned (as Joint Tenants) and will pass automatically to the survivor rather than under the will. If Mr smith leaves his whole estate to Mrs Smith then on Mrs Smith's death £255,000 of the her total £400,000 estate is tax free. The balance of £145,000 is taxed at 40% i.e. £58,000. Their children would therefore inherit £342,000.

If the Joint Tenancy is severed so that the property is held as Tenants in Common in equal shares each could leave their share of the property directly to the children.

The affect would this would be as follows: -

1. On Mr Jones death his half share of the house is left to the children i.e. £150,000. He leaves his savings of £50,000 to Mrs Jones. No tax is paid at this stage.

2. On Mrs Jones death her estate comprises her half share of the house (£150,000) and savings of £100,000 (£50,000 received from her husband and £50,000 of her personal savings). She leaves all of this to the children. The total of £250,00 to the children is tax free as it is within the nil rate band.

3. Therefore on the death of both the children have inherited a total of £400,000 tax free. (£150,000 from Mr Jones plus £250,000 from Mrs Jones). This compares with £342,000 if the house had not been divided. They have saved £58,000 in tax.

Apart from the residential home it is possible to divided up other assets such as savings to achieve the same affect as above by either eliminating tax or reducing it.

It should be noted that dividing the assets may not be suitable some situations where it may not leave sufficient provision for the surviving spouse. On the death of the first spouse the surviving spouse could be placed at risk in relation to the home if children insist on receiving their share and the surviving spouse is not able to raise the monies. In that event the home would have to be sold in order for the children to receive their share.