Tax Efficient Wills
This article appeared in the April 2006 Issue of Homeseeker.
THIS ARTICLE COULD SAVE YOU £114,000!!
No-one would knowingly pay tax if they didn’t have to, however many people are unnecessarily arranging for their children to pay the Chancellor of the Exchequer, vast sums in Inheritance Tax.
Where once Inheritance Tax was the worry of a few very rich people, these days, many more of us are now subject to it. The latest figures available from the Inland Revenue (for the tax year 1999/2000) state that approximately 4% of estates were liable for the tax, although it is more than likely that this figure has increased substantially since.
Indeed, the recent meteoric rise in house prices has put many people in the position of having estates in excess of £285,000, the limit at which Inheritance Tax begins to be charged. Any assets in excess of this amount (“the nil rate band”; it will increase by £15,000 to £300,000 in April 2007 and to £325,000 by 2009) are taxed on death at a rate of 40%.
So, are there any ways to minimise the liability?
There are several exemptions and allowances available; one of the main exemptions being the “spouse” exemption which is available to married couples and also, since the Civil Partnership Act 2004 came into force on 5th December 2005, to registered civil partners. This exemption allows a spouse or civil partner to inherit the whole of their spouse’s or partner’s estate tax free, without limit.
However, on the death of the spouse or partner, the exemption is no longer available and the former joint estate is now concentrated in one person.
Most married couples, if they have Wills at all (and a great many don’t), have Wills that leave their whole estates to each other, on the death of either, and to their children or other beneficiaries on the death of the surviving spouse. (It is too early yet to see this happening with civil partners but the same principle will apply).
At present, Inheritance Tax (IHT) is paid when someone dies leaving an estate of more than £285,000. The first £285,000 of such an estate is taxed, but at 0%, and so is known as the “nil rate band”. In addition, assets passing between husband and wife or civil partners are exempt from IHT, irrespective of their value; although this ‘surviving spouse exemption’ is available only to couples who are actually married or in registered civil partnerships: not to couples who are merely living together.
Take the situation of a married couple or civil partners whose joint assets are worth £570,000, held in exactly equal shares, and who have Wills of the sort mentioned above. The tax effect of those Wills will be that, on the death of the first spouse or partner, no tax will be paid, but on the death of the survivor there will be a tax bill of £114,000 at current rates (i.e. £570,000 – £285,000×40%). The children of the marriage or other beneficiaries would receive only £456,000 and the Chancellor the remaining £114,000. This is because, on the second death, there is no surviving spouse or partner and so the only ‘tax break’ available is the nil rate band.
Whilst that is bad enough, what is worse is that that tax payment was entirely voluntary. None of that tax need have been paid, if the Wills had been more tax efficient.
Imagine that instead of leaving their entire estates to each other on the first death, the married couple or civil partners’ Wills create what is known as a “nil band discretionary trust” in the estate of the first of them to die, of which the surviving spouse or partner is a trustee, and of which he/she and the children or other relatives/beneficiaries are all potential beneficiaries.
Both income and capital are available to the survivor throughout his/her lifetime at the discretion of the trustees, and, on the survivor’s death, the trust can be wound up and the assets made over to the children/beneficiaries free of tax (assuming no significant growth in the value of the trust estate, greater than the uplift in the ‘nil rate band’ in the interim).
As the trust is a separate taxpayer in its own right, with its own nil rate band, the effect of this arrangement is to make two nil rate bands available on the death of the surviving spouse or partner, rather than just one; doubling the assets which can pass free of tax to the children/other beneficiaries from £285,000 to £570,000, at present rates, and avoiding the tax liability altogether.
Most married couples and civil partners with combined assets of more than £285,000 at the present time would benefit from investing in a more tax effective Will, as the tax saving at current rates could be as much as £114,000!
It is important that heritable property is registered in joint names and without a “survivorship destination” in the title (i.e. without the property passing automatically to the surviving title holder on the death of one of the joint holders). If a survivorship destination is included in jointly held assets, the tax efficiency of the nil rate band discretionary trust arrangement is negated and the careful planning frustrated.
There are other methods of reducing the liability for Inheritance Tax, including the use of lifetime trusts, outright gifts to individuals, use of annual and other exemptions, and investing in certain types of products.
If you think that your estate may be liable to Inheritance Tax, it is advisable that you take professional legal and taxation advice regarding the best method of reducing your liability.
Article compiled by Elspeth Talbot
Posted by Sharon Clift on Apr 16, 2006
