Inheritance Tax (IHT) is a tax that is paid on the value of an individual’s net assets when they die. Very simply, IHT is charged at 0% on the first £325,000 of your assets, and at 40% on the rest, although there are various reliefs and exemptions that may help to reduce its impact.
The IHT legislation is complex with many rules, exceptions, and reliefs and expert guidance is needed to ensure maximum benefit is made of these. This article highlights some of the pitfalls that can arise from failing to take professional help.
Gifting your home to children
The family home is often the most valuable asset an individual owns, meaning that many people believe that it is where to start your IHT planning. However, not taking advice in this area can lead to unintended, unwelcome, and potentially expensive tax consequences.
Most taxpayers are aware of the general rule that if you gift an asset away and survive the gift by seven years the asset gifted is no longer considered part of your estate for IHT. An outright gift is a Potentially Exempt Transfer (PET), and a great way of saving IHT as you can give away substantial assets to reduce the IHT payable on your death. However, PETs are subject to strict rules, and if you make a PET and retain any sort of benefit in the asset you have gifted, the PET fails, and the asset will be treated for IHT purposes as though it was never given away. This is called a Gift with Reservation of Benefit (GWR)
Therefore, if you give your home away and continue to live there as you have before, the GWR rules will apply to the gift and the full value of the property will remain in your estate for IHT purposes.
If you wish to save IHT by giving your home away and continuing to live there, you will need to pay a market rent to whoever you gift it to, usually your children. This will exclude the home from the GWR rules but will mean that you will have to pay a rent to live in your home, and the recipients of the gift will have to declare and pay income tax on the rental income they receive from you. You will also have to continue paying the bills.
As an aside, for all other taxes, the gift will be recognised. This could lead to unexpected capital gains liability on the sale as it is unlikely to have been the new owner’s main residence unless they are co-habiting with you. They could also be liable for higher rates of SDLT should they purchase other residential property.
Despite the above, there are certain circumstances when gifting the family home, or a share of it, can be effective tax planning, but careful consideration needs to be given to the pitfalls above.
Many couples do not realise that it is only married couples or Civil Partners that can pass assets between them without worrying about IHT. For an unmarried couple, even if they have lived together for many years, if the first person to die leaves their estate to their partner, 40% IHT will be payable on the value of assets over the first £325,000. This is particularly unfortunate if the family home is the most valuable asset and there is insufficient cash in the estate to pay the IHT due. Whilst it may be possible to pay any IHT due in 10 yearly instalments, the surviving partner may face the prospect of having to sell the family home to pay the IHT bill.
Not writing life assurance policies in trust
Many people take out life assurance to help loved ones after their death. The policy can provide funds to pay any IHT due or simply ensure those left behind do not fall into financial hardship. But if you have life policies, have you written them into trust?
If a life policy is not written into trust, the policy proceeds will be paid into your estate and could be subject to IHT.
Life assurance companies generally offer the option of writing the policy into trust at no extra charge, or your solicitor can draw up a trust deed for you, and it is possible to put any existing policies into trust after you have taken them out. Checking whether your insurance policies are written in trust could save you many thousands of pounds in IHT.
Another advantage of writing life policies in trust is that the proceeds do not have to pass through probate and the money is therefore available to the executors before probate is granted. The proceeds are available to pay the estate’s IHT liabilities and other liabilities, and to provide for any specific bequests.
Don’t leave IHT planning until it’s too late!
It is easy to leave IHT planning to another day, as life is hectic and there are other more immediate demands taking up your time and attention. However, taking advantage of IHT planning early can ensure that you are doing everything you can to mitigate your family’s potential IHT exposure. Put simply, the earlier you start to make gifts, the more chance there is of surviving them for seven years.
Taking professional advice can help you to avoid the above pitfalls, and to make plans that benefit you, the people and causes that you care about, and minimise the IHT payable on your estate. We would be happy to review your IHT position and assist with any planning to mitigate potential liabilities.
For a better understanding of Inheritance Tax, please read our quick guide to inheritance tax by Oliver Dorrington.
This article is from the latest edition of our A Matter of Tax newsletter. To receive future copies of any of our newsletters directly to your inbox, please visit our preference centre to register your interest.
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