INHERITANCE TAX: THE FACTS

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1 INHERITANCE TAX: THE FACTS

2 INHERITANCE TAX IT PAYS TO PLAN AHEAD I M NOT RICH ENOUGH TO WORRY ABOUT INHERITANCE TAX I NEED MONEY TO LOOK AFTER MYSELF IN MY OLD AGE I LL DO SOMETHING ABOUT IT LATER THESE ARE JUST SOME OF THE THINGS PEOPLE SAY ABOUT INHERITANCE TAX. THE TRUTH IS THAT SOME FAMILIES WILL FEEL ITS SUBSTANTIAL STING BUT THERE ARE THINGS THAT CAN BE DONE TO MINIMISE IT. PLANNING REALLY IS EVERYTHING, AND IT S SOMETHING THAT YOUR FAMILY WILL THANK YOU FOR. AFTER ALL, THERE ARE MANY THINGS YOUR LOVED ONES WILL HAVE TO GO THROUGH WHEN YOU DIE YOU DON T WANT AN INHERITANCE TAX HEADACHE TO BE ONE OF THEM. WHAT IS INHERITANCE TAX? Inheritance Tax (IHT) is a tax that is paid on your estate (everything you own that has any value less any outstanding liabilities) when you die. As long as the value of what you leave behind is not more than 325,000 there won t be any IHT to pay. This amount is known as the Nil Rate Band, and it normally increases on 6th April each year, although is currently frozen at 325,000 until April Generally speaking, if you are a permanent UK resident, everything you own is taken into account when calculating Inheritance Tax, including your home, your savings and life assurance plans even your car. Also, any gifts that you have made in the seven years before your death could be included when the tax bill is worked out, although there are some exemptions, and any outstanding liabilities you may have will also be deducted. HOW COULD INHERITANCE TAX AFFECT YOU? HERE S HOW IT WORKS: Currently if you die and the total value of your estate is not more than 325,000, there is no IHT to pay. However, if your assets are worth more than 325,000, everything over that amount will be taxed at the current rate of 40%. The actual amount of tax that will be charged depends on the rules in place at the time. You can build up a potential Inheritance Tax bill without even realising it. The value of your home on its own could take you over the Nil Rate Band. When you add up everything you own, you could be surprised at how much it s worth. Even ornaments you have had for years could be worth a lot more than you think. Read on to find out more about what you can do. 1

3 HOW USE OF THE NIL RATE BAND OR A WILL CAN HELP WITH YOUR TAX In the past there were Inheritance Tax (IHT) implications if a spouse* didn t use his/her Nil Rate Band on first death. If the first spouse to die did not use their Nil Rate Band on death it would be lost. Legislation was announced in October 2007 which now allows the surviving spouse s* legal personal representatives to claim an enhancement of his/her Nil Rate Band by the unused percentage of Nil Rate Band on first death. * Spouse includes any person who is registered as a civil partner (as defined by the Civil Partnership Act 2004). The following scenarios show what you could do: SCENARIO 1 Mr Robertson dies in 2007/08 and does not use any of his Nil Rate Band (100% unused). He leaves everything ( 300,000) to his wife Jane. There is no IHT due at this point because transfers between spouses are free of IHT. When Jane dies in August 2011 (2011/12), her estate is worth 650,000 which she leaves to her children, Sarah and John, in equal shares. Her legal personal representative claims an enhanced Nil Rate Band on her behalf. There is no tax to be paid on the 650,000 estate as her Nil Rate Band will be 650,000. The Nil Rate Band of 325,000 in 2011/12 is enhanced by 100% (100% of her husband s Nil Rate Band was unused). So the children end up receiving the full 650,000 estate between them when their mother dies. An alternative to the above could be scenario 2. SCENARIO 2 Mr & Mrs Robertson have Wills written leaving the Nil Rate Band to Sarah and John when the first of them dies. Mr Robertson dies in 2007/08 when the Nil Rate Band is 300,000 (100% used). There would be no Inheritance Tax to pay at this point as the legacy is not more than the Nil Rate Band. When Jane dies in August 2011 (2011/12), her estate is worth 325,000 which she leaves to Sarah and John. This again is tax-free because it is within the Nil Rate Band ( 325,000) for 2011/12. (No enhancement can be claimed as Mr. Robertson fully used his Nil Rate Band on his death.) So Sarah and John have received 625,000 in total ( 300,000 in 2007/08 and 325,000 in 2011/12) and no IHT was paid on either first or second death. In the second example although the overall legacy appears less, in fact the sum inherited on first death may grow and of course is outside Jane s estate. The overall IHT liability is the same (nil) in these examples whether everything is left to the surviving spouse on first death or not. However, there will be situations where it is important to use the Nil Rate Band on first death. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. 2

4 HELP REDUCE THE VALUE OF YOUR ASSETS BY MAKING GIFTS ANOTHER POSSIBILITY IS TO CONSIDER MAKING GIFTS BEFORE YOU DIE, WHICH MAY HELP REDUCE THE VALUE OF YOUR ASSETS INCLUDED WHEN THE TAX BILL IS WORKED OUT. GIFTS THAT ARE FREE FROM INHERITANCE TAX Any gifts between spouses are free from IHT. In addition, the following exemptions are available on which no IHT will be payable: 1. You can gift up to 3,000 a year (your annual exemption). 2. If you do not make gifts of more than 3,000 in one year, then any unused part of your 3,000 limit for that year can be added to your 3,000 limit for the next again year. You can carry over for one year only. 3. You can make as many small gifts as you want, as long as the total given to any one person is not more than 250 in any one year. Please note that it is not possible to use both your annual exemption (see point 1) and the small gifts exemption as gifts to the same person in the same year. 4. HM Revenue & Customs (the Revenue) also allows you to make wedding gifts, which are free from Inheritance Tax. You can give 5,000 to each son or daughter, 2,500 to each grandchild and 1,000 to anybody else. 5. Inheritance Tax will not have to be paid on gifts that are made to charities, national museums, universities, the National Trust, political parties and certain other bodies. When you make a gift or transfer assets over to someone, even to a member of your family, some of it may be free from being assessed if it falls within any of the exemptions already described. If you die within seven years of making a non exempt gift, the full value of the gift at the time you made it is included in the value of your assets. It would therefore be included when IHT is worked out. If you die within three to seven years of making a gift, any IHT payable on the gift is reduced on a sliding scale depending on the number of years you ve survived after making the gift. Remember that to avoid an IHT liability, the gift-maker cannot benefit from making the gift. A gift that you still retain an interest in is likely to still count as part of your estate. For example, if you make a gift of shares to someone, you cannot keep the right to receive any profit from these shares. If you did keep the right to receive profit, then the Revenue wouldn t view this as a gift for IHT purposes, so the value of your shares would still be liable for IHT in your estate. 6. If you can show that regular gifts are being made out of your income and not out of your savings and that they are not having a negative effect on your standard of living, then they too may be free from Inheritance Tax. This is known as the normal expenditure out of income exemption. 3

5 MAKE SURE YOUR LOVED ONES BENEFIT BY SETTING UP A TRUST A trust is a way of helping to get assets out of your estate. The benefits of a trust are that if assets are not in your estate, not only will they not be included in any IHT calculations; they can go straight to the beneficiaries after your death. There are three different people or groups involved in setting up a trust: The settlor is the person who sets up the trust. The trustees are the people who manage the trust in accordance with its terms. The beneficiaries are the people who may, or will, benefit from the trust. There are several different types of trust available just take a look at the list below and the type you choose will depend on your needs. Some trusts even allow you to access the funds while you re alive. Bare (absolute) trusts Under a bare trust, the beneficiaries are entitled to all the assets of the trust. The main duty of the trustees is to manage the assets for the beneficiaries and then transfer on to them when required. Interest in possession trusts Under an interest in possession trust, the named beneficiaries have the right to receive income from the trust, although the trust assets do not necessarily have to produce an income. The trustees may have the power to pay out capital from the trust to any of the beneficiaries at any time, if they think this is appropriate. Discretionary trusts Under a discretionary trust, the trustees have power over any income and they also decide on how and when the trust assets are paid out. There is usually a wide range of beneficiaries, but no specific beneficiary has the right to capital or income from the trusts. If you are considering setting up a trust, please contact your financial adviser for help with this and for information on the trusts that Scottish Widows offers. 4

6 USE A LIFE ASSURANCE PLAN WRITTEN UNDER TRUST TO HELP PAY THE IHT BILL AS THE VALUE OF YOUR HOME AND ALL YOUR POSSESSIONS WILL BE INCLUDED IN YOUR ESTATE FOR INHERITANCE TAX PURPOSES, YOU MAY NOT BE ABLE TO AVOID INHERITANCE TAX. IF ALL ELSE FAILS, AND DESPITE CAREFUL PLANNING THERE WILL BE AN IHT BILL, THEN THERE IS STILL A SOLUTION. YOU COULD SET UP A REGULAR PREMIUM LIFE ASSURANCE POLICY FOR THE ESTIMATED IHT AMOUNT AND WRITE THIS INTO A TRUST TO ENSURE THAT A LUMP SUM OF MONEY IS AVAILABLE TO HELP PAY THE IHT BILL WHEN YOU, YOUR SPOUSE, OR BOTH OF YOU DIE. The proceeds from a life assurance plan written under trust will be available immediately, enabling any tax bill to be settled quickly, which could be a great help for your family. This is because when a life plan is held under trust, the death benefits can be paid to the trustees without having to wait for a grant of probate, or letter of administration, or, in Scotland, a confirmation. It is important to make sure that you always have additional trustees in place to ensure the proceeds can be paid quickly without the need for probate. A grant or letter or confirmation is needed by the Revenue before any of the assets in your estate can be used, sold or passed on to your family or beneficiaries. Without it, payment of any assets to your family or beneficiaries will be delayed. In addition, a grant or letter or confirmation is not usually issued until the IHT bill has been paid. Without a life assurance plan in place to cover the tax, a loan on which interest would be charged may be required to cover the tax. The loan and any interest would have to be repaid from the estate. When doing this, the important points to consider are: To make sure that the Inheritance Tax bill would be covered, you should aim to arrange for the lump sum payable from the plan to be at least the same as the amount of tax that you expect will be charged. The people who are liable to pay any IHT bill after you die, would have to be included as beneficiaries under the trust. You should ensure that the trustees know who you wish the death benefits to be paid to. If you are considering putting a life assurance plan under trust, please contact your financial adviser for help with this. They will also be able to provide you with details of the life assurance plans that Scottish Widows offers. Alternatively, if you want to invest a lump sum in a plan and put it under trust, Scottish Widows offers a number of trust options that may help you reduce the amount that is taxable in your estate when you die. This could reduce the Inheritance Tax bill and help you ensure that your loved ones benefit, not the taxman. Again, your financial adviser will be able to give you details. 5

7 THINGS TO CONSIDER It s important to be prepared when it comes to Inheritance Tax. For example your house may be worth more than you think and this could mean you will be liable for IHT. Why not make a list of all your possessions? Many people are surprised at exactly how much their estate comes to when they include things like precious household ornaments and antiques. It s also extremely important to think about Inheritance Tax as early as you can. The reasons for this are as follows: The older you get, the more expensive it will be to take out a life assurance plan to meet any tax bill. Inheritance Tax can be reduced by making use of exemptions each year. The earlier you take action the more you can make use of them, ensuring that your money goes where you want it to before and after you die. If you make gifts when you are younger you have a better chance of surviving them by seven years, therefore making them free of Inheritance Tax. So your loved ones benefit, not the taxman. To find out if your estate is likely to be affected visit the calculators section on our website at and select the Inheritance Tax Planning calculator in the Investments calculators section. This brochure represents Scottish Widows interpretation of the law and HM Revenue and Customs practice as at date of publication. This information is based on the assumption that tax legislation is not changed. WHAT NEXT? At Scottish Widows we believe one thing above all else; forward planning is vital, especially when it comes to your finances. After all, in today s fast-moving financial climate, can you really afford not to be prepared? For more information about Inheritance Tax planning and what you can do to help yourself and your family avoid paying more tax than you need to, please contact your financial adviser. 6

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