Inheritance tax (IHT) once affected only the seriously wealthy; these days it is a problem for many people who could not be described as rich by any stretch of imagination.
The change is due mainly to property prices rising far faster than the nil-rate band (the amount of assets exempt from IHT). If the value of your worldwide assets — your home and other property, savings, investments and other assets, sometimes even insurances — are worth more, after deducting your debts, than the nil-rate band, then you should consider planning how to avoid IHT.
The nil-rate band rose in last month’s Budget to £300,000 for the 2007/8 tax year (from £285,000) and will rise to £350,000 by 2010/11. However some experts say the staged increases are still not large enough to offset house price inflation: for a high percentage of people exposed to IHT, their home often accounts for the bulk of their estate on death.
With careful planning, however, IHT is often avoidable. Most couples have relatively simple ‘mirror wills’ which in essence state: ‘If I die my spouse gets my estate, if they die I get theirs and if we both die the children get the lot.’
The problem with this is that most couples own their properties as ‘joint tenants’, which means they each own 100 per cent of their home.
When the first party dies, joint assets pass automatically to the surviving spouse (or partner, in a civil partnership) and there is no IHT to pay as transfers between spouses are exempt.
However, the first spouse’s personal nil-rate band is then lost, so on the second death the full value of the property is included in the estate — only one nil-rate band will be used, and the excess over it will be taxed at 40 per cent.
The good news is that married and civil partners can reduce an IHT bill by each setting up a discretionary will trust. To do this, you change the ownership of your home to ‘tenants in common’, so that you each own a 50 per cent share of it.
You do not need to place any assets in these trusts: your executors will have the power to settle the amount due to the trust. On the first death, half of the home (or estate) up to the value of the nil-rate band at the time will go to the trust. The trustees ‘lend’ the assets held by the trust back to the survivor.
On the second death, the total value of their estate will be calculated, with the loan effectively reducing its value by the amount of the first deceased’s nil-rate band.
The remaining estate is taxed after applying the survivor’s nil-rate band. Both nil-rate bands have been used and IHT of £120,000 (in 2007/8 terms) has been avoided.
Liz Willis is from the Medical Profession Advisory Division, St. James’s Place Partnership, 07900 654401, firstname.lastname@example.org