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A Guide to Inheritance Tax

WHAT IS INHERITANCE TAX? Inheritance Tax is a tax that may be charged on a transfer of value from one person (the donor) to another (the donee);

� at the time of the transfer;

� upon the death of the donor, or;

� as a consequence of the actions or inactions of the donee.

The death of a person will cause them to be treated as if they had made a transfer of value equal to the value of their entire estate immediately before their death. Many people feel they do not need to worry about inheritance tax. It is true that no liability arises if the estate on death is less than the nil-rate band (£285,000 in 2006/2007) or where the estate is left to an exempt beneficiary, such as a surviving spouse, civil partner or a charity. However, as personal wealth and property values increase, more and more people need to consider estate planning. So if your home alone is worth around £285,000 or more, inheri-tance tax will almost certainly fall due on your estate. Furthermore, cash deposits, directly held shares and securities and PEPs/ISAs account for nearly one half of financial assets in estates where inheritance tax is payable.

So it is not just the super rich who need to consider in-heritance tax planning with their financial adviser. Many ordinary families will lose a substantial slice of their as-sets if they do nothing. Inheritance tax is a significant source of taxation and the rate charged on death is currently 40%. Take the exam-ple of a married couple, where the survivor leaves a taxable estate of £700,000. The tax payable amounts to nearly one quarter of the gross estate on the death of the second person. This means that ,if the estate if left to three children, they each receive little more than the Inland Revenue. So what can you do to reduce the Tax Man’s slice?

Taxable Estate £700,000

Less nil-rate band (£285,000)

Taxable Estate £415,000

Inheritance Tax @ 40% £166,000

Available to beneficiaries £534,000

“If you have an estate valued at more than £285,000 you may be concerned about Inheritance Tax. We suggest you ensure that your will is up to date and reflects your wishes and you find out whether setting up Trusts would be of benefit. I can help you to achieve the above as well offer further solutions to reduce your exposure to Inheritance Tax. Why not contact me to ar-range a no obligation meeting?” Mark Horner, Managing Director, Family First Financial Services Ltd

Contents What is Inheritance Tax?.………………………………………………………………………………………………………….. Make a Will………………………………………….………………………………………………………………………………… Make use of exemptions…………………………………………………………………………………………………………… Are there any other Tax Reliefs……………………………………………...…………………………………………………… Trusts………………………………………………………………………………………………………………………………….. Common Trusts……………………………………………………………………………………………………………………… Life Assurance……………………………………………………………………………………………………………………….. What will the Tax Man receive from your Estate?........................................................................................................... Your options…………………………………………………………………………………………………………………………..

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MAKE A WILL

The first step in inheritance tax planning is to make a will. Without a will, your estate will be subject to intestacy rules, which could mean that the things you leave behind do not go to the people you would have chosen. Also, more inheri-tance tax may be payable than would have been if you had made an efficient will. The best way to make a will is to seek expert advice from a lawyer or a will writing specialist. All you need to do is know who you wish to receive items from your estate. A will can be altered once death has occurred, but only with the agreement of all the beneficiaries affected. This is a complex area and should not be seen as a substitute for tax planning. Professional advice must be sought. Wills should be reviewed regularly to ensure they are still reflecting your wishes and circumstances and to ensure the will meets your requirements. You can consult a professional individual to assist in the writing of the will, however, this will usually incur some cost. There are a number of exemptions that could be used to immediately reduce that value of your estate. If used cor-rectly they are the most efficient way to reduce any inheri-tance tax bill. If you can afford to gift some of the assets you own it may be possible to reduce the size of your estate, which could immediately reduce your potential inheritance tax bill.

MAKE USE OF EXEMPTIONS

One of the simplest solutions is to give your assets away, however, gifts will only avoid inheritance tax if they meet two conditions; they must be made without any ‘strings attached’ and be made at least seven years before death. It would not, therefore, be acceptable to the Tax Man if you simply gave your house away, but continued to live in it, unless you pay a ’market value’ rent to live in the property. It is not all bad news in respect of gifts made within seven years of death. Such gifts are called ‘Potentially Exempt Transfers’ and are subject to a reduced sliding level of tax.

How do seven year gifts work if I die sooner? In addition to the seven year rule, a number of further ex-emptions are available. These include: ► All assets transferred between spouses or civil partners are free from inheritance tax. On first death, it is logical to maximise use of the nil-rate band with the balance of assets passing to the surviving spouse or partner. However, when the survivor dies, tax will then be chargeable on any remaining assets over and above his or her nil-rate band allowance. ► An amount up to £3000 given away each tax year, which is commonly known as your ‘annual exemption allowance’. Any unused allowance can be carried forward one year. ► Gifts you make as part of normal expenditure out of income such as regular payments for a gifted life assurance policy. ► £5000 for your children’s marriage/civil partnership, given either to your child or to their prospective spouse/ partner. ► £2500 for your grandchildren’s marriage/civil partner- ship, given to either party.

► £1000 to anyone else getting married or entering a civil partnership. ► Payments for the maintenance of your spouse/civil partner, ex-spouse/civil partner, dependent relatives and usually your children who are in full-time education or under 18. ► Individual gifts not exceeding £250 to each person in any one tax year. ► Gifts to charities, the National Trust, National Museums, registered housing associations and political parties are exempt from IHT. More than one exemption can be used at the same time. For example; you could give £8000 to your child when they get married:- £5000 would be exempt as a gift to your child on their wedding and the remaining £3000 could be your an-nual exemption allowance for that tax year.

Years between transfer and death

Percentage of tax charged (taper relief)

0-3 100%

3-4 80%

4-5 60%

5-6 40%

6-7 20%

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ARE THERE ANY OTHER TAX RELIEFS?

Depending upon your own circumstances, part of your es-tate may be eligible for tax relief. For example, if you are transferring a business, tax relief is available if you have owned the business for, at least, two years and providing that business is not an investment company. It is possible for this exemption to be as much as 100% for sole traders and partnerships, although only assets that are predominately used, or will be used, for business purposes are eligible for exemption. In addition to sole traders and partnerships, business prop-erty relief is available on unquoted shareholdings as well as farms, agricultural land and woodland. You must have owned the farm for, at least, two years or owned a share in it for, at least, seven. Bear in mind that plant and machin-ery do not qualify for relief against inheritance tax, although they may be eligible for business relief.

TRUSTS

There is often a mystique surrounding trusts. Put simplisti-cally, a trust is a legal arrangement where you choose a third party (called a Trustee) to hold some of your assets for someone else (called a Beneficiary). If structured carefully, trusts can assist in reducing or eliminating your inheritance tax liability. Some trusts involve making a gift, which will reduce the value of your estate. Like any other gift, not covered by one of the exemptions mentioned, the assets placed into certain trusts are considered to be a potentially exempt transfer. If you survive seven years there will be no inheritance tax to pay on the value of the gift. One advantage of using the trust is that it allows you to retain some control over the asset you want to gift. In March 2006, the Government announced its intention to amend the taxation of certain trusts used for inheritance tax purposes. The bill has now passed through parliament and the following changes have taken place:- Previously, any lifetime gift to lifetime discretionary trusts

was treated as a potentially exempt transfer (PET). This meant that any beneficiary, with an entitlement to income under the trust, would have the value as part of their own estate for IHT purposes. These trusts will no longer be treated as PETs and will be subject to the mainstream inheri-tance tax regime. The mainstream inheritance tax regime for trusts means that when a trust is created there is an immediate charge to tax at 20% on lifetime transfers above the nil-rate band (£285,000 for 2006/2007). A periodic charge applies (maximum 6%) every 10 years on the value of the trust assets above the nil-rate band and an exit charge applies when capital is distributed to beneficiaries between 10 year anniversaries.

COMMON TRUSTS ► Interest in Possession Trusts ► Accumulation and Maintenance Trusts ► Nil-rate band Trust/Will Trust ► Probate Trust ► Loan Trust ► Discounted Gift Trust ► Gift Trust Trusts are complicated and must be set up very carefully. You should speak to us and we will advise you on which Trust, if any, would be best for your needs. Making the decision of which route to take is not straightfor-ward and is very much dependent upon your requirement for access to income and/or capital. You will notice, from the preceding pages, that the more the investor is prepared to sacrifice in terms of access, the more effective the plan is for reducing the IHT bill. We can give you specific advice on what the best options are for you. We can also carry out periodic reviews with you. Investing a little time and thought now means you could rest easy, knowing that the people you want to leave your pos-sessions and wealth to will not be faced with an unexpected tax bill at a difficult time. No one wants to think about what will happen when they die. This is probably why too few of us make wills or take a serious look at our money and the finan-cial impact our death will have on our families. Planning to reduce a potential tax bill on your death need not be a difficult process. With a little planning now, you can save your family a lot of financial pain later and ensure that they benefit from your estate, not the Tax Man.

“The same rules apply to farms, agricultural land and woodland”

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LIFE ASSURANCE A life assurance plan, placed under trust, is not used to reduce the inheritance tax bill but can be used to pay the bill on death. Provided the plan is placed under a suitable trust , it does not form part of your estate and the money is available im-mediately upon death. The plan has to be set up carefully and is something we can help you with. If you make a mis-take, you could actually make the inheritance tax bill even bigger than it would have been without the plan. Any payout which is over the nil-rate band could be liable to a 6% tax charge, if you are unlucky enough to die, or are seriously ill, on the 10th anniversary of the trust. Existing life assurance policies written under trust will not be affected by changes introduced in March 2006. If policy terms are varied, the trust will still be protected provided the original terms of the policy allowed for the specific change. Changing the beneficiaries on an existing flexible trust, after 6 April 2008 (other than as a result of the death of the de-fault/named beneficiary) will bring the trust into the new re-gime. Policies can be written under a bare trust and are unaffected by the changes, although these are inflexible and you should seek specific advice from us. Example: Henry has assets of £350,000 which he is leaving in his will to his wife Jane, who also has assets of £170,000. On Henry’s death his money would pass to Jane free of inheri-tance tax, but increase the value of Jane’s estate to £520,000, which for their family could mean a large tax bill of £94,000 on Jane’s death. As Jane required Henry’s money to provide her income after his death, he did not wish to pass any of his assets to his family in his will. Henry took out a Joint Life assurance policy for £94,000 payable into a suitable trust for his family on the second death. On the death of the last survivor, this money was paid to the family free of tax and was used to pay the inheritance tax bill of £94,000 due on the estate, leaving the family with the full benefit of their inheritance.

WHAT WILL THE TAX MAN RECEIVE FROM YOUR ESTATE?

Use the following table to work out your potential liability to inheritance tax, on second death, if you do nothing.

Assets Yours Partner Joint

Properties

Vehicles

Savings

Policies

Pension pot

Investments

Valuables

Contents

Other

Total

Liabilities Yours Partner Joint

Mortgages

Loans

Credit Cards

Overdraft

Funeral

Other

Total

Total Assets -

Total Liabilities

Left over 1 2 3

Total value (1+2+3)

Deduct £285,000

Taxable Estate

Tax @ 40%

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Don’t let the Tax Man take your hard earned cash!

You have three main options when deciding what to do about your potential inheritance tax bill...

DO NOTHING

If you do nothing your estate may have an inheritance tax bill to pay

on your death.

SPEND YOUR MONEY By spending your money you could have lots of fun but will not be leav-ing anything for your beneficiaries. Spending your money on assets doesn’t remove the problem as your estate would still be worth the same amount! Also, spending your money isn’t effective Inheritance Tax planning as you can’t predict when you are going to die. If you spend all your money on new as-sets, assets you wish to leave to your beneficiaries may have to be sold to pay your inheritance tax bill (or even to repay the loan they had to take out to pay your bill!). It also means that the Inland Revenue could end up as one of the biggest beneficiaries of your estate.

INHERITANCE TAX

PLANNING

With careful planning, you can ensure that your inheritance tax bill is either reduced or completely wiped out. Your estate passes to your beneficiaries rather than the tax man! Tax planning need not mean giving up access to all of your money.

Family First Financial Services Ltd is authorised and regulated by the Financial Services Authority. Not all tax planning ser-vices are regulated by FSA. This guide is for information only. It is not intended as a substitute for legal or other professional advice and should not be considered as personalised advice. You should seek independent advice from a qualified will writer, solicitor or financial adviser. Taxation levels, bases and reliefs quoted are correct as at November 2006 and the value of tax benefits depends on individual circumstances. You should bear in mind that the Government may alter or withdraw these benefits without notice. The information contained in this report is based on our understanding and interpretation of current

regulations. Any examples used are for illustrative purpose only.

Contact Address: 51 Coniscliffe Road, Darlington, Co Durham, DL3 7EN