To Gift or Not To Gift

How do I save Inheritance Tax? Well you’ve worked hard all of your life, have a nice home and have built up a reasonable ‘nest egg’ for your retirement.    You will probably be unhappy to learn that unless you take steps to prevent it , HM Revenue and Customs could be one of the main beneficiaries of your estate when you die.

Many people feel they do not need to worry about inheritance tax.   It is indeed true that no liability arises if the value of the estate on death is less than the nil rate band currently £300,000 for 2007 / 08 or where the estate is left to an exempt beneficiary like a surviving spouse or a charity.

The chancellor often states that only a small proportion of estates pay inheritance tax.   He does this with the knowledge that each year the amount of inheritance tax collected by the revenue rise’s steadily by an average of 8.5 % each year over the past 5 years.   Total inheritance tax receipts as long ago as 2001/02 were around £2.4 billion.   The Chartered Institute of taxation has predicted around two million households could face the prospect of inheritance tax liabilities within the next 10 years.   So not just the super rich need to consider inheritance tax mitigation planning.   Many ordinary families will lose a substantial slice of there assets if they do nothing.

Example of what can happen if you do nothing

Malcolm a widower aged 71 dies on 26th Sept 2007, he has 2 dependants aged 40 and 45.

His estate is as follows   Property value          £400,000

                                          Investments              £200,000

                                          Cash                         £15,000

Total value of estate                                         £615,000

Current Nil Rate Band 2007/08                       £300,000

Estate subject to inheritance tax at 40%           £315,000

Malcolm’s dependants will have an inheritance tax bill of £126,000 to pay.

So what can we do to prevent this position arising?

The first step may be to take advantage of available relief’s and exemptions.   For example an individual may give away £3,000 each year.   Next you could make an outright gift and as long as you survive 7 years from the date of the gift you will have no inheritance tax to pay.

Unfortunately, many individuals miss the chance to save  tax through lifetime gifts because they are reluctant or unable to lose control of there assets.

The good news is that it is possible to create  tax effective trust arrangements with access to capital and or income.  

LOAN TRUSTS

Aim   You want to reduce your potential inheritance tax bill, but need to keep access to your Capital

You make an interest free loan which is repayable on demand.   The loan is placed in a Life Assurance Bond, written in trust for your chosen beneficiaries.   The Inheritance Tax Benefit is that any growth in the bond will immediately fall outside your estate and go to your nominated beneficiaries.  Your capital can be returned to you monthly or in a lump sum whenever you need it.   On your death any portion of the loan outstanding will be returned to your estate and may be subject to inheritance tax.   In a nutshell, loan trusts allow you to get any growth in your capital free from Inheritance tax, but you keep control of the capital.

Case Study

Malcolm is widowed and aged 71

He has 2 dependants aged 40 and 45

His Estate is valued at £615,000 which includes £200,000 in cash available to invest.

Malcolm understands that as things stand his dependants will have an Inheritance tax bill on his death.

Malcolm needs the income from his investments to support his standard of living and therefore can’t make any unconditional gifts

Solution

Malcolm places £200,000 into a loan trust and requests trustee’s to make repayments of £8,000 each year.  He is aware that these payments can be increased or reduced.

Let’s assume that the investment grows at 4% per annum after all charges and that Malcolm takes loan repayments at 4%  ( £8,000 ) each year.  

After 12 years Malcolm dies.

Investment bond value is £200,000

Outstanding loan is £104,000  ( i.e. £200,000 less 12 x  £8,000 repayments

£104,000 will be included in Malcolm’s estate

£96,000 will not be subject to inheritance tax, giving a saving of 40% x £96,000    Total saved £38,400   

Remember that this is an example, in practice the bond may grow at more or less than the 4% used in this example     

I am very grateful to David Garden of Mike Swann Chase Financial for his kind assistance in producing this article.

David Endicott
Managing Partner