Giving away your wealth to members of your family reduces your estate for inheritance tax purposes, but only after seven years. However, it is possible to achieve the same result without the wait. What steps do you need to take? Inheritance tax expert Brona MacDougall has some valuable advice for you.
Any tax expert will tell you that the simplest way to reduce the inheritance tax (IHT) payable on your estate, and as a result increase how much your beneficiaries will receive, is to pass your wealth on to them sooner rather than later, assuming that you can afford to. To be blunt, the older you get the greater the chance of you dying within seven years of giving away your wealth, and if that happens HMRC will take the value of the gift into account when working out the IHT bill. But the good news is that you can avoid this ‘seven-year glitch’ by making use of IHT exemptions and reliefs.
Exemptions and reliefs
If you give away cash or other assets which are less than the annual IHT exemption (£3,000) or another gift exemption applies, the seven-year rule won’t cause the value of the gifts to be taken into account for IHT. Also, if you own business or agricultural property, the amount on which IHT is payable is reduced by either 50% or 100%. These IHT breaks are well known, less so are those which reduce the value of your estate liable to IHT but don’t involve direct gifts.
Shifting or gifting wealth
Money or wealth used to improve someone else’s situation without actually giving them an asset is a “disposition” of value. From HMRC’s perspective this more or less has the same effect as if you had made a gift. For example, waiving your right to a dividend so that other shareholders get an advantage, or delaying when you take your private pension so that the value which passes to your beneficiary when you die is increased can count as dispositions. However, IHT legislation states that certain dispositions are ignored for IHT. One example is “dispositions for family maintenance”.
Keep it in the family
Inheritance tax free family related dispositions include those for:
• The maintenance of your, or your spouse’s, children while they are under 18 or in full time education
• Your parents or your spouse’s parents.
• Any relative of yours, or your spouse, that is dependent on you for care.
One way to make use of the exempt dispositions is to set up a fund for your child’s education (until they are 18 or, if later, cease full time education) and maintenance. You might pay for or contribute towards these costs as you go out of your earnings or savings. Each time you pay a bill for the education/maintenance of your child it reduces your estate and thus the potential IHT, but you could do better.
Setting aside money specifically for the future cost of your child‘s education and maintenance takes it out of your estate immediately. It’s usual to set up a trust (which you can manage as trustee) to hold the money or assets you earmark for the purpose. That way HMRC can’t argue that the money or assets were intended for another purpose. A solicitor can set up a simple trust of this type relatively cheaply, so for around £1,000 you can protect your estate from considerably higher sums of IHT.
A lump sum set aside for the purpose of paying for the future cost of your children’s education and maintenance is immediately excluded from your estate for IHT purposes. It’s advisable to make the arrangement formal by having a solicitor set up a trust.