The tax man sees your assets - both during your life and on your death - as something to be taxed wherever possible. 

For example, generally, if your estate is valued at £325,000 when you die (including certain gifts you have made in the 7 years before you die) you will have to pay Inheritance Tax at 40% on everything over that level. Income Tax and Capital Gains Tax can also raise their heads.

This is not only a lot of money for your family and beneficiaries to lose out on. In practical terms it can be a problem finding the money to pay the tax if you or the estate are property rich but  cash poor. Often, precious assets have to be sold to pay the tax if money cannot be found or borrowed.

If only you could give your property away before you die - that would ensure your estate never hit the £325,000 threshold at which Inheritance Tax becomes payable. Sadly, there are rules in place that can bring the value of assets you have given away during your lifetime back into your estate when the tax man works out whether you have hit the Inheritance Tax threshold.

Despite these rules, there are still a number of steps you can take, both in your will (which will take effect after you pass away) and also now while you are alive (we call this "lifetime planning”), that can help you to reduce the tax that you would otherwise have to pay.

A.    Tax-planning using your Will

There are a number of things you can do in your Will that "kick in” after your death that can reduce the tax that is payable on your estate.

The main opportunity to do this in your Will and therefore after your death are however much narrower than the "lifetime” opportunities. New laws in 2006 meant that tax planning opportunities in wills were greatly reduced.

Will-based tax-planning options consist mainly of making best use of your tax-free, or "nil-rate”, band. By this, the first £325,000 of your estate is tax-free .

Some beneficiaries can receive gifts in wills with no IHT being payable because of who they are - for example, spouses and charities.

If you want to make gifts to people who do not enjoy this "freedom” from IHT, you can do this efficiently by giving the first £325 000 to them and no IHT would be payable either.

B.    Lifetime planning

Far more opportunities exist for you to take steps now - while you are alive - that can impact on the tax payable on your estate when you pass away.

1. Your annual exemption from Inheritance Tax

You can give away £3,000 of your capital each year and this will not be counted as part of your estate for Inheritance Tax reasons if you die after you have made the gift. If you do not use any part of your annual exemption, it may be carried forward (but for one tax year only).  

2. Using lifetime gifts to avoid Inheritance Tax

With careful planning, further and considerable parts of your estate can be given directly to your heirs now - rather than waiting until you pass away - without those gifts later being included when the tax man calculates whether your estate hits the tax threshold - provided you survive for seven years after you cease benefitting from the gift.  

When making such lifetime gifts it is important that you are confident that you will never again require use of the asset that you are giving away. It is not possible to give an asset away AND for you to then retain use of that asset. The law requires that to take the asset out of your estate for tax purposes you must permanently deprive yourself of the benefit of that asset. If you wish to continue using a gifted asset you must pay a genuine market rent for your use of it. If you carry on using the asset that you have "given away”, the start of the seven year survivorship period is delayed. The asset therefore would never leave your estate for tax purposes as long as you continued to use it.

Nor is it possible for you to start benefiting from an asset that you have given away as soon as the seven years period runs out - you could be hit with an Income Tax charge instead.

HM Revenue & Customs will investigate any arrangement that appears to involve you retaining some form of enjoyment from an asset which you previously owned but which you are claiming you gave away. These investigations are probing and stressful.

Proper advice can ensure that your gift does not fall foul of any of these rules, so that - provided you survive seven years after you give the property away - the value of the asset will not be included when the tax man calculates whether your estate hits the tax threshold, and even if it still does, no tax will be payable on that asset.

Lifetime gifts can also have Capital Gains Tax consequences though. Believe it or not, quite apart from any Inheritance Tax considerations, a lifetime gift of an asset is actually treated by the tax man as a 'sale' of the asset for Capital Gains Tax ("CGT”) purposes. CGT is levied on the "gain” that you make (generally, the value when you gave it away less the value when you acquired it), at 18% (or 28% if you are a higher rate Income Tax payer).

It is possible to avoid this CGT by transferring the asset slowly over several years (as you are allowed to make gains each year of £10,100 without any CGT being payable). Alternatively, you can set up a lifetime trust and you can place the asset in question into that trust in one go (see more on this below).

3. Gifts in contemplation of marriage and civil partnership

It is possible to make gifts to relatives or friends free of Inheritance Tax if they are about to get married or enter into a Civil Partnership. The gift must be made because of definite marriage plans. A parent can give their child £5,000 tax free in this way, and a grandparent can give their grandchild £2,500. Anyone can give any other relative or friend £1,000 tax free. These gifts by you will not be included in the valuation of your estate on your death, and even if your estate is still over the tax threshold, no tax will be payable on these gifts.

4. Small Gift Exemption

This permits the making of any number of gifts of £250 per year to any number of individuals - no such gifts attract Inheritance Tax.

5. Normal Expenditure out of Income

There is a useful exemption from Inheritance Tax that is little used. Should you find that you have surplus income that is not being spent, it is possible for you to give this surplus away, and such payments should not attract Inheritance Tax. The exemption is not limited to any amount. All that is required is that you genuinely have excess income that is not being spent. The gift of excess income should be made with a genuine intention of being a regular feature of your expenditure.

This exemption does require some discipline, as it is necessary to show that you genuinely have excess income over expenditure. It is important that you maintain proper records to permit your Executors to show that the gifts you made whilst you were alive were genuinely out of your excess income.

Good uses for this exemption are the payment of school fees, insurance premiums and allowances to your family.

6. Using Trusts

As set out above, you can avoid Inheritance Tax by giving an asset away while you are still alive. However, you may wish to retain some control over the asset that you are giving away.

You can do this by putting the asset into a trust while you are still alive, as opposed to giving it directly to someone.

The trust can be set up so that you can continue to influence how an asset is dealt with (though you cannot use the trust as a means of retaining a benefit in the asset and of thus getting around the rules discussed above). You may not wish to permit the recipient to sell or gain control over an asset yet because of their age - they may be too young as yet.
 
However, although you can retain control over the asset by a lifetime transfer of an asset into a trust, all lifetime trusts (other than a disabled person's trust) trigger an immediate Inheritance Tax charge - though one that is lower than the death-time charge would be. Inheritance Tax at 20% becomes due when the trust is created and the asset is transferred into it, if the value of the asset exceeds £325,000. That is a lower rate than the 40% that is payable in Inheritance Tax on your death.

Using trusts can be a good route to take with life insurance policies, for example, as it is possible to place life insurance policies in trust. This means that when the policy pays out on your death it has its own nil-rate band and the first £325,000 that it pays out is tax-free. It also means that funds can become available to your dependants immediately on your death rather than them having to wait for a Grant of Probate which can take three months.

It is important that when a life insurance policy is put into trust in this way, only the death benefits are put in trust. If the trust is drafted incorrectly, you could include any critical illness payments that the policy gives you within the trust too which would mean that you would not be entitled to the critical illness benefits under the policy at the time that you most needed them - when you were alive but ill.

Trusts can also be used to deal with assets that would trigger a CGT liability if you gave them away while you were still alive. We mentioned this danger above. We explained how for tax purposes a taxable gain can be made even though you are giving an asset away rather than selling it. If you set up a trust whilst you are alive, you can transfer into that trust both the asset and the "gain” that was made. You personally would not therefore have to pay the CGT at that stage. By doing this and by "electing” what is called "Hold-over relief”, you can postpone the tax liability until such time as the asset is actually sold by the trust at some time in the future.

7. Pension Benefits

Some pensions have large death-in-service benefits - they can be a form of life insurance. If you died, these benefits would ordinarily be paid into your estate and could take your estate over the Inheritance Tax threshold. You can take action to ensure that these benefits are not paid into your estate by making sure that that part of your pension is put into a trust. This would ensure that the lump sum arising on your death does not become taxed as part of your estate.

8. Re-arranging your investments

It is possible to arrange the way you invest your capital to obtain the benefit of some valuable reliefs from Inheritance Tax. With careful investment it may be possible to obtain 100% relief (after 2 years) from Inheritance Tax by claiming what is called Business Property Relief. You are strongly urged to seek advice from a qualified independent financial advisor or stockbroker. We can introduce you to a panel of reputable and independent financial advisors that we work with. 

Investment in woodlands also qualifies for 100% tax relief after five years. It is also possible to purchase units in a woodlands management company. Again, specialist advice should be sought if you wish to explore this opportunity.

9. More Complex Schemes

There are other, more complex tax mitigating schemes. These are extremely varied and we would be able to advise on the most appropriate options when we fully understood your means, assets, circumstances, and wishes

 This summary of options is designed as a brief overview. Our large Private Client Team would be delighted to hear from you and to talk through your circumstances and wishes, at no cost to you.  Once we understood your position and were able to see how we might help you, we would quote a price for the legal work that was needed and you would then be free to "shop around”.

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