It would seem the north-south divide is as wide as ever, certainly as far as inheritance tax (IHT) is concerned.
A recent press article has noted that half of the IHT collected in the UK comes from estates in our region. Undoubtedly, this is a result of ever increasing property prices. For example, in Cambridge, average property prices may be rising by as much as 11% per annum. Indeed, the average house price in Cambridge is now £362,800 – well above the national average.
Why do high property prices affect IHT?
IHT is a tax on wealth. It is calculated by reference to the value of an individual's estate on death including the value of lifetime gifts (outright or into trust) made within seven years of death. There are two rates of IHT: 0% on estates up to £325,000 (known as the nil-rate band, or NRB); and 40% on the value over this amount. Any lifetime gifts will absorb the NRB in priority to the death estate.
There have been comparatively recent changes to the IHT rules where everything is left to a surviving spouse/civil partner. Previously, where this occurred, the NRB of the first spouse/civil partner to die was wasted, but under the current regime, the surviving spouse/civil partner can claim a percentage uplift of his/her own NRB to reflect the fact that the NRB on the first death was not fully used (this is known as the 'transferable NRB'). In practice, if all is given to the surviving spouse/civil partner on the first death then a double NRB of £650,000 is available on the second death.
Even allowing for the transferable NRB, many married couples/civil partners in our region may still have a problem. How may this be mitigated?
Reducing the tax bill
There are a number of straightforward ways to reduce IHT:
Gifts to charity
All gifts to charity, whether made during lifetime or by Will, and regardless of the amount, are exempt from IHT.
Gifts not exceeding £250 to any one person in any one year are exempt from IHT. There is no limit to the number of small gifts that can be made to different individuals.
If you survive for seven years after making an outright gift to someone, it is generally exempt from IHT, no matter what the value.
If you die within seven years, the value of the gifts is added to your estate and will reduce the NRB percentage uplift of the survivor. If the total value of such gifts exceeds the NRB, IHT will become payable.
Gifts into trust
Where you do not want to make outright gifts, you may also consider the use of trusts for IHT planning during your lifetime.
Gifts into trust are generally restricted to the amount of unused NRB taking into account other gifts made within the previous seven years.
As regards both outright gifts and trusts, any growth in value of the gifted assets will fall outside of the donor's estate on his/her subsequent death.
Use of annual exemptions
You are entitled to an annual exemption of £3,000. This means you can make gifts totalling £3,000 tax-free in any one year. If you do not use the exemption in one year, it can be carried forward to the next year, but no further.
Gifts in consideration of marriage
Gifts of up to £5,000 per parent are exempt from IHT. The gift must be evidenced in writing.
Normal expenditure out of income
Any regular gifts made out of after-tax income, not including your capital, are exempt from IHT. These include monthly or other regular payments to someone. There must be evidence of a settled pattern of giving out of surplus income. This exemption can be used alongside/in addition to the £3,000 annual exemption.
Insurance to fund Inheritance Tax
Life insurance may be taken out to fund the estimated IHT bill on death. The two types of life insurance most commonly used in conjunction with IHT planning: term and whole-of-life.
Careful planning is the key
The key to mitigating IHT is careful estate planning. Each of these options requires careful thought and should be considered in tandem with your Will (which is the 'final transfer'). At the same time it is essential you provide for the contingency of mental incapacity by making Lasting Powers of Attorney.
For further information, please contact James Marsh on 01223 411421 or email at firstname.lastname@example.org