Dummies October 2005

In This Extract

* Reducing the likelihood of paying inheritance tax
* Inheriting money the right way
* Making use of everyday tax breaks

Getting your estate into tax-saving shape takes time and thought. But once you’ve taken tax-saving steps you can rest easy knowing that your loved ones will enjoy as much of your money as possible after you’ve gone.

For peace of mind for the future, and more comprehensive advice, read Wills, Probate and Inheritance Tax For Dummies

Use the Nil-Rate Band to the Max

The first ?275,000 of your estate can be gifted free of inheritance tax (IHT). This amount is called the IHT threshold and anything below this is your nil-rate band. Anything over ?275,000 is taxed at 40 per cent (the threshold rises to ?285,000 from April 2006).

Your nil-rate band, combined with the fact that whatever you leave to your spouse, same-sex civil partner (from December 2005), or charity is IHT free, provides you with a powerful tax avoidance weapon.

However, if you leave your entire estate to your spouse, when your spouse dies the combined estates can get hit with a hefty IHT bill.

The best way around this future scenario is to leave enough money for your spouse to live off, with whatever’s left going to other beneficiaries, perhaps to your children. You can give away up to ?275,000 to anyone free of IHT, but that’s your limit!

Own Your Home on a ‘Tenants-in-Common’ Basis

What happens to your home when you die depends very much on what basis you own it. If you own your home with someone else, you are either beneficial tenants in common or joint tenants. If you are joint tenants, then when you die your share of the property automatically passes to the person who owns it with you. If you share property ownership on a beneficial-tenants-in-common basis, each tenant is free to dispose of their share of the property as they see fit through their own will.

Owning your home on a beneficial-tenants-in-common basis gives you far more estate planning options. Dividing your property between your spouse and grown-up children can be a very smart tax ploy. Such a move can reduce the size of the taxable estate on the death of your surviving spouse, because half the house has already been passed to the adult child. You can’t use this tactic if you own a property on a joint tenancy basis with your spouse, because they automatically inherit on your death.

When the first beneficial tenant in common dies, a beneficiary inherits their half share of the house. The beneficiary might then try to force the property to be sold to realise their half share (in other words, get their hands on the money). This leaves the second tenant in common in a sticky situation.

The share of one beneficial tenant in common never passes automatically on death to the other beneficial tenant or tenants in common. You must state in your will who you wish to inherit, or your part of the property will be divided up under the laws of intestacy.

Make Use of Annual Gift Exemptions

Each year you’re allowed to make gifts, which, once made, leave your estate forever as far as the tax collector is concerned. These exempt gifts give you an opportunity to siphon off part of your estate so that any ultimate IHT liability is avoided or reduced.
You’re allowed to make large gifts of up to ?3,000 each year to one person and any number of small ?250 gifts -but every small gift has to go to a separate individual. Over time, you can use exempt gifts to move substantial sums out of your estate and thereby reduce its IHT liability.

Any gifts you make for the ongoing upkeep of a dependant don’t count as part of your estate for IHT purposes.

If the value of the gifts you make exceeds your annual limit, then the gifts are no longer exempt. As a result, if you die within seven years of making the gift, it is included in your estate for IHT purposes.
You’re allowed to carry over the unused balance of the ?3,000 gift exemption from one tax year to the next, but no further.

Give Away High-Value, Low-Income Assets

In later life many people give away their major assets, even their own home. They do so not because they are struck with an altruistic urge to forsake their worldly goods- not a bit of it - but to reduce the eventual tax bill on their estate.

Any assets you give away cease to be a part of your estate for IHT purposes after seven years from the date of transfer. This gifting is called a potentially exempt transfer (or PET for short). The downside of gifting an asset is that once it’s gone, it’s gone. You’re not allowed to gift an asset and still derive an income from it or the tax collector will deem that the asset is still part of your estate. If you gift your home (perhaps to your children), you are not allowed to live in it without paying the proper market rent. The key is to gift assets that you can afford to do without - usually, this means high-value, low-income assets, such as your car.

After three years from the date of the transfer the amount of tax potentially due on a PET worth more than the IHT threshold of ?275,000 starts to fall.

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• Taxing Issues in your golden years

• Wine for Dummies

• Su Doku for Dummies

• Wills, Probate and Inheritance Tax for Dummies

• eBay.co.uk For Dummies

• Starting Your Own Business for Dummies

• Kakuro for Dummies

• Arthritis for Dummies

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Deep-Freeze Your Estate

If you think you have quite enough money to live on - lucky you! -you can freeze your estate. Estate freezing is when you bring all the tools of IHT avoidance to bear, such as exempt gifts, gifting out of income, and potentially exempt transfers - all to make sure your estate doesn’t grow any bigger. In short, as the money comes into your estate through the front door it goes out through the back door! The big idea is that while your estate is frozen, the IHT threshold is increased by the Government and as a result the amount of tax - if any - your estate is liable for falls over time.

Freezing your estate isn’t foolproof and involves a lot of very careful planning. All your carefully laid plans may be undermined by a bumper injection of wealth into your estate such as through a large inheritance, rapidly increasing house prices, or even a mammoth win on the horses!
Get independent financial advice if you want to play the estate freezing game.

Be 100 per cent sure you can comfortably do without any asset that you give away.

Set Up a Trust

Using a trust can really help to get your estate into tax-saving shape.

An asset is held in trust for a set period of time or until a particular event takes place. Trustees take care of the asset in the best interests of the beneficiary, the person who will benefit from it. For example, trustees might keep an amount of money in trust until a child reaches the age of 18.
Trusts work by plucking an asset out of your estate - and if it’s not in your estate when you die, then it can’t be taxed. Trusts can be set up when you’re still alive or through a will.

A trust can reduce an estate’s liability to both IHT and Capital Gains Tax (the tax you pay on the sale of an asset, such as a house).
 

Build Up Exempt Assets

Certain types of assets can be passed on either free of IHT or at a reduced rate. These assets are called exempt assets and the more you have of them in your estate, the less the tax collector can take. Keep exempt assets in your estate and gift the non-exempt ones, like cash.
Exempt assets include business assets, woodland, farmland, and even National Heritage property.

If you’re married and have children, you can reduce IHT by giving non-exempt assets such as your home and savings accounts to your spouse while leaving your exempt assets to your children. Your non-exempt assets become exempt because assets gifted to your spouse are IHT-free.
If your exempt asset is a profitable business, bear in mind that any money taken out of the business loses its exempt status and just becomes part of your ordinary non-exempt estate. So plough back those profits!

Hold on to any exempt assets in your estate: If you sell up, the proceeds are considered part of your estate and are potentially liable for IHT.

Write a Joint, Mirror, or Mutual Will

If you are married, you and your spouse may choose to make your wills at the same time. If you agree over who should benefit when you have both gone, then using a joint, mirror, or mutual will can make sense.

A joint will is a single document stating the wishes of two people. Mirror wills are two wills made in identical terms, although the people making the will can revoke these at any time. A mutual will is very similar to a mirror will, but each party agrees that the wills can’t be revoked.

These types of wills allow you to link up your estate plans with your husband or wife. Using a joint, mirror, or mutual will can be a good way of ensuring that nil-rate bands (the amount of money you can leave free of IHT) are used and exempt assets are left to non-exempt beneficiaries.

Inherit Money Tax-Efficiently

Inheriting money or property can help your finances but it can also create problems. The inheritance may be large enough to push the value of your estate beyond the IHT threshold. You have two options to avoid the snapping jaws of the tax system:

• Distribute the inheritance to your likely beneficiaries through exempt gifts and potentially exempt transfers. Hopefully, over time, your estate plans will absorb the inheritance nicely.
• Instead of inheriting yourself, sign the loot over to your children. This action is called generation skipping and it’s a good option if you don’t really need the inheritance. With generation skipping you avoid future IHT due on your death. The aim of generation skipping is to stop a bumper inheritance from taking your estate above the threshold for IHT.

If a beneficiary dies soon after inheriting from an estate that has already been subject to IHT, then quick succession relief may be available, meaning that you don’t pay as much IHT. The closer the second death is to the first, the more relief from IHT can be claimed.

Take Advantage of Your Tax Breaks

Take steps to reduce the amount of tax you pay during your life to pass on more to your loved ones when you die. The tax collector isn’t generous by nature so when you see a tax break, grab it with both hands.
Some key tax breaks to consider include:

• Buying a pension. Contributions you make into a personal or company pension scheme have generous tax relief. In effect, every 78p you pay into your private or company pension, the Government tops up to ?1, or more for higher-rate taxpayers. What’s more, some pension schemes are structured so you get a large lump sum on retirement and your loved ones get a cash pile if you die before retirement.
• Saving in an ISA. Normally, your savings are taxed at 20p in the pound - more if you’re a higher rate taxpayer - but you’re allowed to shelter up to ?3,000 a year in a mini-cash Individual Savings Account (ISA). Over time, you can save a lot of tax this way and leave a larger savings pot behind for your loved ones. You can pop up to ?7,000 worth of shares into a stocks and shares ISA each year. Any money you make on the shares is free of Capital Gains Tax (CGT). However, the more money you leave to loved ones, the more IHT may be due.
• Buying tax-free investments. Some National Savings investments and index-linked gilts (bonds issued by the Government) - in effect, loans to the Government - are allowed to grow in value free of tax. The more of these investments you have, the less the tax collector eats into your estate.

Just because an investment is tax-efficient doesn’t make it right for you. National Savings and gilts are tax-efficient and very safe, but they are unlikely to grow as fast as some other investments. Consult an independent financial advisor (IFA) if you want more advice on investing.

Tax breaks are available for people willing to invest their money in small and medium size businesses through Venture Capital Trusts and Enterprise Investment Schemes. Paying Less Tax For Dummies by Tony Levene (Wiley) is crammed with tax-reducing tips. If you want to know about these specialist investments go to www.taxefficientreview.com

(The above is an extract from Wills, Probate and Inheritance Tax for Dummies)

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