IHT Solutions
- Gift Allowances
- Exempt Gift Allowances
- How to Make Gifts
- Important Changes to Trust
- Loan Trust
- Discounted Gift Schemes
- Life Assurance Policy
Gift Allowances
There are a range of allowances which you can use to limit your Inheritance Tax liability, although the major ones are as follows:
Nil Rate Band
Each person has an allowance of £325,000 or £650,000 if you are married, in a civil partnership or widowed. This includes: properties, personal effects, cars, savings, investments and insurance - collectively known as your estate.
Exempt Gift Allowances
Annual Exemption
Everyone is entitled to give away £3,000 exempt from Inheritance Tax in any one tax year. If not previously used, then this allowance can be backdated one tax year, so in effect £6,000 could be given per donor to begin with, thereafter £3,000 per annum (optional).
Marriage Gifts Exemption
Each parent can give wedding gifts of up to £5,000 to each of their children. Grandparents can gift up to £2,500 to each grandchild. Also, you can give up to £1,000 as a wedding gift to anyone else. These gifts must be given before the wedding day.
You can make gifts utilising more than one of the above allowances to the same person. For example, as a parent you individually could give your child in the year they are married, £5,000 plus £3,000 (Annual Exemption) as another gift.
Small Gifts Exemption
Any number of gifts to different people up to a value of £250 each can be made in a tax year. If the total value of gifts to any one person exceeds £250, then all gifts to that person must be deducted from the £3,000 Annual Exemption mentioned above.
All of the above have the effect of reducing the estate upon which the Inheritance Tax can be levied.
Making Gifts
In most cases, any direct gift amount either made direct or into an absolute trust by any one person over the exempt gift allowances, is a Potentially Exempt Transfer (PET). This means that you as the donor, need to live 7 years, from when the transfer is made for the gift to fall outside your estate. During the 7 year period the amount of tax payable reduces each year. This is known as Taper Relief. However, this relief only applies to the part of a gift which is in excess of the nil rate band (£325,000).
How to make Gifts
As mentioned above, for a Gift to be fully efficient for Inheritance Tax you must survive 7 years from the date of the gift and you cannot have any access to the monies gifted for your own benefit.
There are two main ways to take advantage of the excellent benefits offered by Gifting:
Direct Gift
This is a convenient and rewarding method of giving items or sums of money to beneficiaries for their immediate benefit. There are, however, also some pitfalls with regards to this:
- Would you want your beneficiaries to have access to this item immediately? What if you think it more appropriate for them to have access to it at a later date?
- What if your beneficiaries’ circumstances change, for example they get divorced? Having ownership of a valuable item or sum of money might affect a future settlement against them if a divorce or separation were to occur.
- What if your chosen beneficiary were to die? Whatever you have given them would be distributed by the terms of their Will, possibly to somebody you would prefer not to receive your gift.
- What if you change your mind about who should benefit? Once you make a direct gift you cannot change the beneficiary because you have lost control of the item.
Gifts to Trust
This method allows the placement of monies in a suitable investment and then this is wrapped within a Trust, of which you and other people of your choosing can be trustees. The monies remain in Trust and all, or amounts of this, can be distributed when you choose.
Important changes to Trust
Before we go into some detail about the type of Trusts available, it is important that you are made aware of some significant changes that were announced in the 2006 Budget. The Budget introduced changes to the way in which transfers into Trusts with an interest in possession are treated from a taxation perspective.
These Trusts are now taxed under the Chargeable Lifetime Transfer regime and as a result there are three potential Tax charges to consider:
Immediate Tax Charge
There is now the potential for an immediate tax charge based on the amount gifted into Trust at outset. The tax rate is currently 20% if paid by the Trust or 25% if paid by the settlor, calculated on the amount gifted in excess of the available nil rate band (£325,000 in the 2010/2011 tax year) at the time the gift is made. The value of the available nil rate band will be reduced by the initial amount of any gifts into Trust made within 7 years of the creation of the Trust being considered that are subject to the Chargeable Lifetime Transfers taxation regime.
10 Yearly Periodic Charge
10 years after the Trust has been created, and thereafter on each subsequent 10 year anniversary, a Periodic Charge may be applied. The Periodic Charge is currently 6% and will be applied to the portion of the Trust assets that are in excess of the available nil rate band in that tax year.
Proportionate Exit Charge
The amount of the Proportionate Exit Charge is based upon the length of time between the distribution of assets and the most recent 10 year anniversary (or the start date if an immediate charge applied), 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.
Loan Trust
This type of plan could be suitable for those people who wish to take steps to mitigate Inheritance Tax but still wish to retain access to their original capital. Based upon an investment bond (or any other suitable investment) which is placed in a Loan Trust, any growth on the investment belongs to the Trust and is free of Inheritance Tax, whilst the original investment belongs to the settlor and is fully accessible at any time and remains within the estate.
Discounted Gift Schemes
As mentioned previously in this Guide, outright gifts can be a highly efficient method of mitigating Inheritance Tax. Although they are not suitable for many people because of the loss of access to income from the investments they gift away, an income which many people rely on to live or even to provide the occasional luxury. Discounted Gifts are a way of giving the money away, (it is Inheritance Tax-free after 7 years), but the person who makes the gift can also have access to a regular, predetermined income for life. In addition to this - based on a number of factors including age and level of income selected - there could potentially be an immediate discount’ to Inheritance Tax. This means an investment into a Discounted Gift Scheme usually results in a saving in Inheritance Tax from the moment the monies are placed in the plan.
Life Assurance Policy
Despite all these methods of mitigation of Inheritance Tax, there is sometimes no option but to simply insure the liability using a Whole of Life Policy. Under some circumstances, this can be a cost-effective way of providing for the eventual bill and can be reasonably simple to set up. The Whole of Life Policy has a sum assured which is paid to the beneficiaries on death, plus due to the fact it is written under Trust, it can be paid prior to the rest of the estate being released and can, therefore, be used to contribute towards or pay for the Inheritance Tax bill on your estate.