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How to minimise inheritance tax

Shane Stack of Medical Money Management advises GPs how to protect their beneficiaries from the burden of inheritance tax

Shane Stack of Medical Money Management advises GPs how to protect their beneficiaries from the burden of inheritance tax

Inheritance Tax (IHT) is a tax levied at death on estates valued in excess of £312,000 (tax year 2008/9) or £624,000 in total for married couples and civil partnerships.

Obviously a great many GPs will need to seek advice in this area, and there are several established and legitimate planning opportunities available to those with estates potentially affected by the tax.

Deeds of variation

A deed of variation is one planning option. It involves altering an individual's will within two years of their death. It still remains the most effective and instantaneous way to reduce a potential inheritance tax liability where the opportunity exists.

Provided certain formalities are observed, the gift of an inheritance made by deed of variation will be treated for inheritance tax purposes as if made by the deceased.

As no beneficiary is treated as owning the discretionary trust fund for inheritance tax purposes, the inheritance is immediately removed from the beneficiary's taxable estate.

Mind you, the introduction of a transferable nil rate band (see below) means that deeds of variation will become largely unnecessary to retrospectively utilise a deceased spouse's unused nil rate band.

Nil rate band planning

The 2008 budget introduced a transferable nil rate band for married couples and civil partners where the second death occurred on or after 9 October 2007.

The amount available for transfer is the percentage of the nil rate band unused on first death, but applied to the nil rate band threshold applicable at the date of death of the survivor.

Example – transferable nil rate band

John died on 20th February 1997 leaving a small legacy of £10,000 to each of his three children and the balance of his estate to his wife Louise. In 1996/97 the nil rate band was £200,000 and the percentage unused was therefore 85%.

Louise dies on 15th March 2008 with an estate of £500,000 – somewhat in excess of her individual nil rate band for 2007/08 of £300,000. However, by claiming John's unused nil rate band of £255,000 (i.e. nil rate band of £300,000 x 85%), Louise's executors will have no tax to pay.

The introduction of a transferable nil rate band means that the nil rate band of a married person (or person in a civil partnership) will not be wasted even if all assets are left to the survivor on first death.

Using your will to plan

Nonetheless situations will still exist where it is appropriate to implement planning in your will. These include:

• A second and subsequent marriage. A discretionary will trust will be useful in second marriage scenarios where leaving everything to a surviving spouse to the exclusion of children from a former marriage is undesirable.

• Asset protection. Use of a discretionary trust in your reduces the possibility of assets being taken into account when assessing eligibility for local authority assistance in the event of the surviving spouse requiring long term care. A discretionary trust in your will also offers some protection in the event of the bankruptcy or divorce of a beneficiary.

• Fast growing assets. These would be assets likely to grow at a faster rate than increases in the nil rate band.

Exemptions, reliefs and absolute outright gifts

Non-contentious planning makes use of available exemptions and reliefs. It is the fundamental first step for individuals who still have a liability even after use of both nil rate bands. In this regard, individuals and their advisers should consider:

• Ensuring the current £3000 annual exemption is utilised.

• Making regular exempt gifts out of surplus income to reduce the size of the estate.

• Ensuring maximum use is made of business and agricultural property relief where these are available.

• Taking advantage of the potentially exempt transfer regime to make outright gifts to individuals or to trusts where this is appropriate.

Gifts to discretionary trusts

Where an individual is happy to make an outright gift in which he or she reserves no benefit, provided that an element of flexibility and control over who gets what and when can be retained, a chargeable transfer to a discretionary trust should be considered.

If the amount gifted is below an individual's available nil rate band, there will be no inheritance tax to pay either on creation of the trust or for at least the next 10 years.

Insurance based schemes

Loan trusts and discounted gift and income plans are attractive propositions to the UK domiciled individuals who wish to reduce their taxable estate but also to retain some form of access to their investments.

Loan trusts offer the option of access to the original investment amount – either on a regular or ad-hoc basis – while removing the investment growth from the taxable estate. The amount of the original investment in the individual's estate for inheritance tax purposes will reduce as withdrawals are taken (provided these are not accumulated elsewhere in the estate).

Discounted gift and income plans enable an individual to make a reduced or discounted gift, achieving an immediate reduction in the taxable estate for inheritance tax purposes and moving capital outside the estate altogether after seven years.

At the same time and income for life (or until the trust fund is exhausted) is retained, and complete flexibility over the ultimate distribution of remaining capital is achieved.

Funding for liabilities with life insurance

Where a liability still exists after all other acceptable planning options have been exhausted, funding for the liability using whole of life policies (life assurance) written under trust should be considered.

Funding for the liability offers you a straightforward, comparatively low cost solution where gifts (premiums paid) will normally be covered by an exemption. Indeed HMRC seldom query this method as they still get their "pound of flesh"!

In my experience most of my clients use a combination of the above solutions. However whatever route you choose you should always seek independent financial and legal advice.

Shane Stack is a partner at Medical Money Management, specialist Independent Financial Advisors to the Medical Profession. You can contact him at shane.stack@mmmnet.co.uk . Medical Money Management is authorised and regulated by the Financial Services Authority

Will

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