15 WAYS TO REDUCE IHT, INCOME TAX & CGT

While most of our work is in the area of reducing Inheritance Tax (IHT) by creating Family Trusts, there are other ways to avoid IHT. Some of these can also reduce your family's liability to income tax and capital gains tax as well. Here follows a summary of 15 ways in which you may be able to reduce your family's IHT Bill.

1. THE BASICS OF INHERITANCE TAX (IHT)

What's taxed and what's not.

When you die, you can pass any amount of assets or savings to your spouse or civil partner without any inheritance tax to pay. But anything you pass to your children or any other party over the value of £300,000 will be taxed at 40%.

Transfers to parties made up to 7 years before your death may be counted back into your estate under 'Potentially Exempt Transfer Rules'

Bequests to charities can be free of IHT.

Some business assets can be passed on free of IHT.

Life insurance held subject to trust can be passed on free of IHT.

Lump sums from pensions can be passed on free of IHT.

Some Investments (AIM investments) can be free of IHT.

While many people are caught by inheritance tax, our experience shows that the majority of families can reduce the amount of IHT they pay by preparing a suitable will and family trust and arranging their affairs in a tax efficient manner before they die.

2.THE DISCRETIONARY WILL TRUST WITH IOU CLAUSE

A low cost, low risk arrangement which leaves the survivor in control of assets and savings. Can save up to £120,000 tax.

If one partner in a marriage or civil partnership dies and passes everything to the survivor, there is no IHT at that point, but if on second death, the allowance of the first to die is lost and only the first £300,000 is tax free. In its simplest form a Discretionary will trust allows both partners in a marriage to use their personal allowance of £300,000 so that the children receive up to £600,000 tax free.

It’s highly flexible as the trust does not exist until the first death and as it’s been around for at least fifteen years and survived an extensive review of trust taxation by the treasury it’s not likely to be attacked in the near future, if properly drafted and administered. The main attraction for most married couples is that it leaves both or one of in control of and owning their own assets until they are both dead. For the above to work, you need to consider equalising your estates and ensuring property is owned ‘in common’ rather than ‘jointly’.

In addition, a Discretionary trust can prevent a Local Authority from taking all the value of your home from you if you have to go into long term care.

Finally, a discretionary trust can mean that your children and grandchildren may pay much less income tax on any interest generated by their inheritance, as all beneficiaries can use their personal tax allowance against income distributed by a discretionary trust.

3. LEAVE SOMETHING TO THE CHILDREN ON 1st DEATH

This can save the children up to £120,000 but the survivor loses control of the funds to their children.

Both partners in a marriage or Civil Partnership can leave up to £300,000 free of IHT to anyone they wish. So if Dad dies and leaves the first £300,000 to the children, when mum dies, the children get another £300,000 tax free.

The obvious drawback is that most families have their savings tied up in the house and wouldn’t want half the house to go to the children. If it did, there are tremendous risks to mum’s financial security and she may even half to pay additional tax if she continues to live there.

4. LIFE INSURANCE TRUSTS

There's almost no reason not to place any life policy you have on your own life in trust for your partner. It avoids IHT on the proceeds and ensures payment is made promptly.

As most life policies don’t pay out until you die, it’s sensible to place them in trust. That way if you die, the money is paid into a trust for your partner and the children. As Trustee and beneficiary, they can have full use of income and capital and control the investments until they die. But on their death, the funds are not included in their estate for the purpose of calculating inheritance tax. So your children can receive the fund free of IHT.

Again, funds held in a properly worded trust cannot be attacked by local authorities, creditors or divorcing spouses and your children may be able to receive the income free of income tax.

Even policies which have maturity values like endowments can be placed in trust for your partner while retaining the value for yourself should you survive.

Unfortunately, joint policies cannot be placed in trust for each of the insured partners. So for the purposes of avoiding inheritance tax, it's usually best for partners to have individual policies held in trust for each other.

5.OUTRIGHT GIFTS

Giving assets away can avoid IHT on them. But you have to plan far ahead to avoid being caught by Potentially Exempt Transfer Rules (PET). You also need to consider the Capital Gains Tax Implications.

Of course you can give your assets away, but unless you are very wealthy, most people don’t know if their savings will be enough for their old age and are very reluctant to make gifts without strings. However, if you do make a gift, you have to live for at least 7 years before it’s completely free of IHT. You can make some gifts without them being Potentially Exempt Transfers which count towards the IHT calculation. But at £3,000 per year or £10,000 in consideration of marriage, it would take a long time to make a dent in £100,000. Gifts over the current ‘nil rate allowance’ (£300,000) have to be declared at the time they are made and could be subject to a Lifetime Transfer Tax of 20% at that time.

However, there is a rule that says ‘Gifts out of normal income’ are exempt. In brief this means that if you earn £50,000 pa and save £12,000 pa you can gift this to your children and it is immediately out with the reach of IHT.

If your capital is increasing, this can be a useful tool, but you are giving your money away and your offspring can use it as they wish. One way to retain control is to gift it into a trust with yourself as trustee. You then control who gets what and when. Recently, the Chancellor introduced additional taxes on this kind of trust, so you should check the implications before considering this option.

Avoiding Capital Gains Tax on Property Transfers

If you transfer shares or a property which is not your main residence to your children you may avoid IHT But if it has risen in value, you could pay up to 40% of the gain in value when you pass it to your children if you are not careful.

Capital Gains Tax or CGT of up to 40% is due on any profit you made over £8,800 when you dispose of that asset. Even if you give it away, the tax is due. So if you bought a flat for £80,000 and it's now worth £100,000 your gain is £20,000 you could pay around £5,000 capital gains tax just to pass it on to your children. However, if you ensure it is held jointly with your spouse first and transfer a smaller share in two separate tax years, the CGT payable is nil.

6. DISCOUNTED GIFT SCHEMES

If you are over 70 and require income but don't envisage using the capital, this may be of interest.

These are the trusts marketed by various Life Companies. In brief, if you place capital into a trust for your children but continue to take an income, the Revenue may grant a pre-agreed discount on the potential IHT if you were to die tomorrow. It all hangs on your age and health. Someone in good health around age 80 might get an immediate discount of up to 50% as a rough example. So if you need your income, but not your capital, this may help.

You have to be in good health, so it's not an option for anyone who is already ill.

7.GIFT AND LOAN SCHEMES

If you think you might need your capital, but don't need the income it's generating, this may be of interest.

This is almost the mirror of a Discounted Gift Scheme. Again, these are marketed by the Life Companies and advice from a qualified adviser is necessary. Under these arrangements, you set up a trust and make a loan of capital to it. The income and gains generated by the loan goes into trust for your children and grandchildren. You can’t get the income back, but you can get the capital if you need it. The income is protected from inheritance tax, but the capital is returned to your estate on your death and is not.

Of course you can probably save the same amount of IHT by simply giving the income to your children and grandchildren as a ‘gift out of normal income’ as described above and achieve the same savings. The advantage placing it in trust gives you is that you can be the trustee and decide who gets what and when. And if one of your beneficiaries gets into trouble, divorces or become bankrupt, your hard earned savings won’t be affected and they can be held back until the problems are resolved or distributed among the rest of your heirs.

8. BUSINESS TRUSTS

If you own a family business or have shares in a small company, this may be of interest.

Most businesses (Excluding those that are purely investment or Property Companies) receive 100% IHT relief when they pass to another member of the family. So a self-employed joiner who leaves his workshop and business to his son, shouldn’t be worried about IHT on the business. However if his house and savings mean that he will be paying inheritance tax in any case, he can use a business trust to increase the value of the assets that pass down the line.

In brief, if you leave your business asset, say shares in a small, family company, to your spouse along with substantial savings, only the shares are tax free when your wife dies and passes your estate on to your children. However, if you leave your shares in trust for your wife, she can then purchase the shares from the trust and, then pass the shares free of IHT to your children. As the trust is free of IHT anyway, the savings are now protected.

For this to work, all parties have to run the business or own the shares for at least two years, but it’s a useful strategy to know about. Like all strategies, it may be attacked by the revenue who will challenge anything they view as an abuse of the rules in court. Even if they lose, they may have the law changed so you can’t use this in the future.

9. BUY TO LET PROPERTY DEBT

This strategy is of interest to Landlords with a property portfolio, but in our opinion, is likely to be challenged by the IR in future.

As we get down this list we move from sensible and prudent tax planning into the area of ‘Tax Loopholes’. This is definitely a strategy I’d describe as a ‘loophole’ and is therefore more likely to be unavailable three years from now.

With more and more people investing in buy-to-let property we are becoming a nation of land lords. As property business are not exempt IHT it means that anyone who has built even a modest portfolio will be facing a substantial IHT bill on these investments alone.

However the IR has just lost a case where a family set up a loan company first. This company was not an investment company but a commercial lending business which lent the family the money to buy the properties. Essentially the properties were mortgaged up to the hilt, but the family owned the shares in the mortgage company. As a result, when Mum and Dad died, their property portfolio was sold and the loans re-paid to the loan company. Although some IHT was paid on the increased equity value of the portfolio, the majority of value went back into the loan company whose shares, increased in value by the repaid debt, passed to the rest of the family free of IHT as a legitimate loan business.

Although this family won the case, the argument is not yet over and I suspect this is not a strategy that will be around in three years time. However, if it’s within your means and there is change of government before the rules are changed, it might be worth looking at.

10. PASS YOUR MORTGAGE ON TO YOUR CHILDREN

Some lenders are now pre-authorising selected descendants to take over your mortgage instead of your equity.

If you want your children to inherit your home and would prefer to invest your spare funds in investments that are inheritance tax free to your children there are lenders who will agree to allow your children to take over the loan on your death. If you pay off of a £100,000 loan on your £400,000 home, when it passes to your children they could pay £40,000 IHT.

However, if you invest the money you would have used to pay off the loan in a business, holiday home, AIM investment or simply pass the funds to your children as PETs, which can all be free of IHT, they can receive a house worth £400,000 with a £100,000 loan and another £100,000 of tax free bequests. As a result, the IHT is nil and they can decide whether or not to repay the loan with these funds or continue paying the mortgage.

11. SECOND PROPERTIES

If you own a holiday home, you can avoid IHT and capital gains tax by giving a share to your children.

If you give a share in your main home to your children and they don't live with you, you will suffer up to 40% 'Pre Owned Asset Tax' on the estimated rental value unless they live with you and share the bills as in the case of a child caring for elderly payments.

However, the pre-owned assets rule doesn't apply if you own a holiday home that you use for a few months a year. Let's say you have a flat in Spain worth £150,000 and have 2 children. If you give each of them a share of one third and you live for 7 years, you won't be caught by Pre-Owned Asset Tax or the Rules surrounding transfers or PETS (Potentially Exempt Transfers)

If the property has risen in value, make consider transferring the property in smaller 'slices' so you and your partner can use your capital gains tax allowances and thereby avoid tax on the gains made.

12. GIVING TO CHARITY

Bequests to charities are not subject to IHT

Leaving something to a registered charity will avoid IHT on that gift. It won’t benefit your family, but it will avoid inheritance tax and might also do quite a lot of good.

13. ALTERNATIVE INVESTMENTS

Investment in companies listed on the Alternative Investment Market can pass free of IHT. However, these are high risk investments and not for the faint hearted.

Investments in the ‘AIMS Markets are by definition risky, but can pass to your children free of IHT if you have held them for two years or more. You need to know what you are doing before making any decision to invest. So take advice from an advisor first.

14. DEED OF VARIATION (E&W) or DEED OF FAMILY ARRANGEMENT (Scotland)

After the first death, you can still save on the IHT. But don't depend on this option being around for ever.

Finally, it always pays to act in advance. Very often, tax breaks that exist today are withdrawn tomorrow and many people are left kicking themselves that they didn’t act sooner. Often the death of a partner means that your good intentions will no longer be effective.

The advice you will get from everyone is to act now, while you are able.

However, if you are a widow or widower or your civil partner has passed away within the last two years, you can re-arrange their will in retrospect to take advantage of the Discretionary Trust or nil rate band allowance. You need to have the agreement of all beneficiaries and the assistance of a good lawyer, so it’s not cheap. Any beneficiary may object and scupper your intentions.

It’s also a matter of record that the Labour Party had it in their 1996 manifesto to do away with this and so it may not be around when you finally come to need it.

15. ASK YOUR PARENTS TO SET UP A TRUST IN THEIR WILLS
Don't let your inheritance be taxed twice.

If you inherit £100,000 from your parents which is taxed at 40% and you then allow it to be taxed again when you leave it your children, the Inland Revenue will take £64,000 (40% of the original £100,000 and 40% of the remaining £60,000) and your children will receive £36,000.

It may be difficult to discuss these matters, but if your parents can be persuaded to include a trust in their will, you could avoid inheritance tax on your inheritance completely.

You could also avoid income tax on the interest generated. Any tax paid on interest distributed by a trust can be claimed back by the beneficiary. So if your parents leave you £100,000 in trust of which you, your spouse and your children are beneficiaries and you pay the £5,000 interest to the children, it's not seen as coming from their parents.* Instead it's seen as coming from their grandparent's trust and as such they can use their personal allowances to reclaim all tax on that interest. If you have three children, your family trust could provide over £15,000 pa tax free.

*Only the first £100 of interest from funds passed from parents to children may be held as tax free.

16. SPEND IT

If you don't have it, they can't tax it.

If you’ve worked hard, why not splash out a bit! If you haven’t got it, they can’t tax it and the memory of a once in a lifetime holiday like a world cruise is definitely not taxable!

You can see that there are lots of options which is why IHT is called a 'Voluntary Tax'.

But to save inheritance tax, you have to act before you die, before the tax rules change and while you are able.

Procrastination is the Inland Revenue's greatest ally. So do

ACT NOW

Contact us on 01563 821117 for further help and advice.


All figures are based on tax allowances for the 2007 – 2008 tax year and our understanding of tax law at 1st February 2007.

The above strategies are examples only. No advice to act is offered. Please contact UK Will and Trust 01563 821117 for a free personalised report if you have concerns that your family may have to pay inheritance tax on your estate.


Posted on 15 September 2007 at 09:16 by John