Estate planning and the basics
As my old PE teacher used to say about rugby, it is all about “simple things done at speed”. He was, of course, as mad as a badger. However, if he was talking about IHT and estate planning (and any tax planning to be honest) he was at least partially right. It is so important to cover off the basics. If these do not get you to where you want to go, only then consider the more complex planning to sort you out.
Much estate planning will involve making lifetime transfers to utilise exemptions and reliefs or to benefit from a lower rate of tax on lifetime transfers.
However careful consideration needs to be given to other factors. For example a gift that saves IHT may unnecessarily create a capital gains tax (CGT) liability. This is because, perhaps counter intuitively, a gift is generally deemed to trigger a gain based on it market value at the time of transfer despite the fact no money or other consideration may have changed hands.
Furthermore the prospect of saving IHT should not be allowed to jeopardise the financial security of those involved.
Use of heavy PET-ting
Wherever possible gifts should be made as Potentially Exempt Transfer (PETs) rather than as chargeable transfers. This is because the gift will be exempt from IHT if the donor survives for seven years.
Of course, if one cannot afford to make outright gifts, or have reservations about doing so based on the potential recipient, then one may need to consider other methods of reducing your estate. There are many such options available:
- Annual exemption
There is a general ‘annual exemption’ which allows every person to give away up to £3,000 per annum without any IHT implications.
If unused in a particular tax year, the annual exemption may be carried forward to the next year but not thereafter.
- Gifts between husband and wife (and Civil Partners)
Gifts between husband and wife are generally exempt. It may be desirable to use the spouse exemption to transfer assets to ensure that both spouses can make full use of lifetime exemptions, the nil rate band and PETs.
Of course, this exemption, in conjunction with the ‘exemption’ for CGT purposes for spouses, may also be useful if one is seeking to transfer income producing assets or assets pregnant with capital gains in to the name of a spouse who would suffer a lower rate of tax. But that is another story.
- Small gifts
Gifts to individuals not exceeding £250 in total per tax year per recipient are exempt. The exemption cannot be used to cover part of a larger gift.
- Normal expenditure out of income
This is an interesting and potentially valuable relief tucked away in the IHT legislation. It is often missed by practitioners and taxpayers alike.
Gifts which are made out of income which are typical and habitual and do not result in a fall in the standard of living of the donor are exempt.
Payments under deed of covenant and the payment of annual premiums on life insurance policies would usually fall within this exemption.
However, someone who can show that they have ‘surplus income’ in, say, a bank account is well within their rights to give this away without any tax implications subject to the provisos above.
- Family maintenance
A gift for family maintenance does not give rise to an IHT charge. This would include the transfer of property made on divorce under a court order, gifts for the education of children or maintenance of a dependent relative.
- Wedding presents
Gifts in consideration of marriage are exempt up to £5,000 if made by a parent with lower limits for other donors.
- Gifts to charities
Gifts to registered charities are exempt provided that the gift becomes the property of the charity or is held for charitable purposes.
- Life assurance
Life assurance arrangements can be used as a means of removing value from an estate and also as a method of funding IHT liabilities.
A policy can also be arranged to cover IHT due on death. It is particularly useful in providing funds to meet an IHT liability where the assets are not easily realised, eg family company shares.
As the main IHT liability is likely to arise on death, a sensible and up to date Will is important.
Business property relief (BPR)
When ‘relevant business property’ is transferred there is a percentage reduction in the value of the transfer. Generally speaking this will either provide 100% or 50% relief.
Where the property in question consists of shares in an unlisted trading company then, assuming it does not have significant investment assets and activity, it is likely that such a transfer will benefit from a full exemption from IHT.
In cases where full relief is available there is little incentive, from a tax point of view, to transfer such assets in lifetime. Of course, there may be perfectly good personal or commercial reasons to do so.
Additionally no CGT will be payable where the asset is included in the estate on death. However the reliefs may not be so generous in the future and therefore gifts now may be advisable.
Agricultural property relief (APR)
APR is similar to BPR and available on the transfer of agricultural property so long as various specific conditions are met satisfied.
Nil Rate Band (“NRB”) and seven year cumulation
Chargeable transfers covered by the NRB can be made without incurring any IHT liability.
Like some kind of Marvel superhero (or is it Doctor Who?), this NRB regenerates every seven years such that older gifts are no longer taken into account in determining IHT on subsequent transfers.
Therefore every seven years a full NRB will be available to pass assets out of the estate.
As well as being regenerative, the NRB also transferable.
For a number of years, it has been possible for spouses and civil partners to transfer the NRB unused on the first death to the surviving spouse for use on the death of the surviving spouse/partner.
On that second death, their estate will be able to use their own NRB and, in addition, the same proportion of a second NRB that corresponds to the proportion unused on the first death.
This allows the possibility of doubling the NRB available on the second death. This arrangement can apply where the second death happens after 9 October 2007 irrespective of the date of the first death.
Residence Nil Rate Band (“RNRB”)
In their manifesto ahead of the 2015 election, the Conservatives stated that it would “take the family home out of tax by increasing the effective Inheritance Tax threshold for married couples and civil partners to £1 million”.
In response to this, the Chancellor announced proposals to bring into force the election pledge in the Summer Budget 2015 and the provisions were duly enacted in Finance (No 2) Act 2015.
In true Frankenstein’s monster style, the RNRB provisions can be found stitched on to the existing NRB legislation and, as such, also to the transferrable NRB provisions.
The rules are overly complex, indicative of the fact that the relief is intended to be given with one hand and then, where the estate is above a certain threshold, whipped away with the other.
The rules only apply to residential property that is included in an individual’s estate on death and left to children and descendants (including step children) and /or their spouses. The property must pass into the estate of the descendant or onto a favoured trust for their benefit;
The property must have been occupied by the individual as a residence at some time but does not need to have been their main residence. It is possible to choose which property obtains the relief via an election.
The legislation will apply to deaths from 6 April 2017, with the full effect of the legislation will be phased in over a number of tax years:
- 2017/18: £100k;
- 2018/19: £125k;
- 2019/20: £150k; and
- 2020/21: £175k
Readers may work out that former Chancellor Mr Osbornes £1m promise is maintained for couples by doubling the NRB (2 x £325k = £650k) and then adding a doubled RNRB (£175k x 2 = £350k).
Whilst the relief is calculated by reference to the value of the residential property transferred on death, it is applied across all of the chargeable estate.
Any unused relief can be transferred to a surviving spouse or civil partner on a claim.
Where a spouse or civil partner has died prior to 6 April 2017, the surviving spouse will be able to claim the deceased persons RNRB. The deceased does not need to have owned a property.
As mentioned above, what is given with the left hand is taken away with the right. The relief is withdrawn by £1 for every £2 the estate exceeds £2m – so for an individual it is lost after £2.35 million (with the precipice being £2.7 million for a surviving spouse).
The value of the estate for the purposes of this threshold is calculated before reliefs such as BPR and APR. Therefore, where an individual or couple have a valuable interest in, say, the family business then this will mean that the RNRB is not available. However, it should be possible to plan to prevent this being lost.
Housekeeping points around the legislation
As previously mentioned, the legislation is pretty complex, a result of which will take some time to bed in.
Even though the legislation does not come into force until April 2017, one should consider the rules where Wills are being drafted and in situations where it is anticipated that one spouse or civil partner has a strong chance of dying before 6 April 2017 perhaps as they have an impaired life expectancy.
Consider the following:
- The new rules only apply to transfers of relevant residential property on death. As such, property gifted just before death cannot qualify.
The restriction of the amount of relief applies by reference to the value of the estate on death. It is worth pointing out that this does not include failed PETs. Therefore, it might be appropriate to make gifts pre death of other assets. Bearing in mind that the value of BPR property is included in the estate for the purposes of tapering away the RNRB, one should explore whether making gifts of this property (there should be no tax on such a transfer assuming held for two years etc) would help preserve the RNRB. Of course, personal and commercial reasons may overrule any such strategy.
- The RNRA is not available on transfers to relevant property trusts.
- The likely value of the estate of the surviving spouse needs to be considered, there is no point passing all of the deceased’s assets to the spouse and with it the full RNRA if the spouse is likely to have a combined estate on death greater than £2.7 million;
- Gifts with reservation of benefit will qualify for the relief as the value will be included in the estate of the deceased.
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