Will your family be able to benefit from a £1 million Inheritance Tax threshold? While you may not have put much thought to this during the election campaign, Anthony Ward, from our Wealth Advisory team explains why now is perhaps a good time to review your estate planning strategy.
It was no surprise that Inheritance Tax (IHT) was hotly debated amongst political parties in the pre-election campaign. IHT is a key tax for the UK purse, with The Office of Budget Responsibility forecasting the Treasury will receive £4.2 billion in 2015/16 from IHT receipts.
IHT is charged at a rate of 40%, with each person currently having their own inheritance tax threshold (known as the ‘nil rate band’) which gives them an amount of £325,000 that is available to be left tax free to beneficiaries. The amount by which a person’s estate exceeds the nil rate band is then subject to IHT at the 40% rate. However, gifts between spouses or civil partners (in life and on death) benefit from the IHT spouse exemption (i.e. they pass free of IHT). In addition, where, on the death of the first spouse or civil partner, that deceased individual’s nil rate band is not exhausted, any remaining nil-rate band can be transferred to the surviving spouse or civil partner and used on that person’s death. However, for any couple with an estate in excess of £650,000, IHT will be payable on the death of the second spouse or civil partner.
What is changing?
A key component of the Conservatives’ manifesto was the pledge to take the family home out of tax for all but the richest by increasing the effective Inheritance Tax threshold for married couples and civil partners to £1 million. The proposal is for this to be achieved by introducing a new transferable main residence allowance of £175,000 per person is proposed to be added to the existing inheritance tax threshold of £325,000 in circumstances where a family home or other main residence is transferred to a direct descendant of the deceased, including step children and adopted children.
How does it work?
The 'main residence nil rate band' would be transferable between married couples and civil partners to the extent that it is not used on first death. Note this new allowance would not be available to offset against assets other than the family or main home, nor would it be available where the home is left to other family members for example those who are not direct descendants of the deceased.
The Treasury expects that the new main residence allowance will reduce the number of estates liable to inheritance tax by the end of the next Parliament. This addresses public concerns about the number of estates of modest size being exposed to IHT due to rising house prices.
How to benefit from your Nil Rate Band now?
It is clear that the above proposals, if passed by Parliament, will help with passing wealth on to future generations. However, you do not have to wait until death before benefiting from your nil rate band. Making a lifetime gift can be an effective and tax efficient way of reducing the size of your estate and passing money on to beneficiaries. Naturally, this will depend on your unique circumstances and you might have reservations about gifting capital directly to others. For example, how do you decide who to gift assets to and could gifting assets outright cause friction within the family or are the recipients mature enough to manage their own wealth?
The answer to these questions can often raise some difficult issues, particularly if you are looking to provide financial assistance to grandchildren who are minors. It could also be that gifting assets outright to your children may well give them Inheritance Tax issues of their own.
Trusts, as explained in the case study below, can offer a solution to these problems with the added advantage of you as a trustee being able to retain an element of control over the assets you are gifting into trust. Individuals can gift as much as they like to a trust but if they gift up to their available nil rate band of £325,000 to a discretionary trust it will be free of IHT. This can be repeated every 7 years (provided they do not make any other transfers chargeable to Inheritance Tax). After 7 years an individual’s nil rate band is effectively ‘refreshed’ which allows tax free gifts to trusts to be made up to the value of the nil rate band every 7 years.
Richard, who is 65, decides to use his available nil rate band and gift £325,000 of cash to a discretionary trust. He appoints himself as a trustee along with a professional trustee to ensure the trust assets are administered appropriately and to provide continuity should he die. Richard is excluded as a potential beneficiary to avoid adverse tax consequences and so cannot benefit from the trust. The trust money is invested for the benefit of his children and grandchildren and he writes a non-binding letter of wishes to the trustees so that they understand his wishes and to provide guidance as to how he would like them to exercise their discretion when it comes to the distribution of income and capital from the trust to beneficiaries in the future. (Note that, although the trustees are not legally obliged to follow the wishes (which can be amended by Richard at any time), the trustees would usually give them careful consideration when exercising a discretion. Should Richard die within 7 years of making a gift to a trust, the amount gifted would reduce the nil rate band available on his death so that a larger portion of his estate would become liable to IHT at 40%.
Seven years later Richard is 72 and decides to gift a further £325,000 to the discretionary trust. Richard dies at age 80 and, as it has been more than 7 years since he gifted capital to the trust, the gifts are both fully outside his estate for IHT purposes. Upon his death his estate is able to use his full nil rate band to pass wealth on to his family. Therefore Richard has been able to benefit from his nil rate band twice during his life and then again upon death. By addressing his estate planning strategy during his lifetime this has allowed him to pass on considerable wealth without any IHT charge.
It should be noted that, if a trust is created, every tenth anniversary of the creation of the trust and on interim and final distributions from the trust, there may be a charge to IHT. Currently the effective rate of this tax cannot exceed 6%.
Appointing yourself, a friend or family member to be a trustee carries a lot of responsibility under law to manage the assets within the trust on behalf of the beneficiaries diligently as well as the administrative burden of tax returns and HMRC reporting. It therefore may be worth considering a Professional Trustee, who can be appointed to manage the trust’s objectives proactively, provide expert opinion, maintain accurate records and fulfil accounting requirements. A Professional Trustee should also provide regular reviews and keep up to date with changing and complex trust legislation.
Therefore a Professional Trustee can save a family considerable time and effort whilst offering an independent view through any family disputes. Having a Professional Trustee in place may also provide continuity for the family by being a trustee over the life of the trust and as wealth is passed through the different generations of the family.
If you would like more information about Estate Planning, Discretionary Trusts or the Barclays UK Professional Trustee service, please speak to your Private Banker who can put you in touch with a Wealth Planner.
“Barclays does not give tax or legal advice. We strongly recommend that you obtain your own independent tax and legal advice tailored to your individual circumstances. In particular you should take legal and tax advice on the creation of a trust. Thereafter, you should ensure that your independent legal and tax adviser keeps you informed of any relevant changes in UK tax law and published HMRC practice.
The views expressed in this document are based on our understanding of applicable UK tax law and current HMRC practice. UK tax law, and HMRC practice, may change at any time.”
If you have questions relating to the articles, please contact your Private Banker.