inheritance tax (IHT) & trusts        
updated 17 October 2007

what is inheritance tax?
what is a trust?

What is Inheritance Tax?

Inheritance Tax (IHT) is essentially a tax on death. It is often described as being "a voluntary tax", meaning that it is avoidable with the right assistance and planning. It is certainly true that many people are frequently astonished at the amount of IHT that is payable upon the death of a relative or friend. With a rate of 40% payable on all assets over £300,000 (from April 2007) it is easy to see how the tax can mount up if care is not taken during your lifetime to minimise your potential liability. (NB The Chancellor of the Exchequer announced in his Pre-Budget Report that for deaths on or after 9 October 2007 it will be possible for spouses and civil partners to transfer their unused inheritance tax nil rate band allowances).

So what can and should you do? While the simple answer is to give all your assets away before you die this may not always be the most prudent and tax efficient way. Here are a few tips for you to consider, but take professional guidance before taking any action.

Exemptions
There are several exemptions to IHT, these are

• the Nil Rate Band - As we have already said you only pay IHT on cumulative transfers of assets over £300,000 (from April 2007). Below this figure it is a "Nil Rate Band".  £300,000 may sound like a lot, but remember it is absolutely everything that you own - including your house.
• transfers between spouses - No IHT is paid on any transfer of assets on death from husband to wife (if both have the same domicile), or vice versa. Whilst this appears very generous it often merely delays the IHT liability until the other spouse dies. Also The Chancellor of the Exchequer announced in his Pre-Budget Report that for deaths on or after 9 October 2007 it will be possible for spouses and civil partners to transfer their unused inheritance tax nil rate band allowances.
• annual gift of £3,000 - You can give away up to £3,000 worth of gifts every year to whoever you like, and if you can afford to do so, you should try and use this exemption every year.
• gifts out of income - regular gifts out of surplus income, as opposed to capital, are exempt from IHT. This is a little used, but quite useful exemption, but gifts do need to be regular.
• small gifts of up to £250 - This is £250 per person, but it cannot be the same person you gave the £3,000 annual gift to. Useful if you have plenty of cash and several grandchildren.
• gifts on marriage - You can give £5,000 to your own child on their getting married, £2,500 to your grandchild and £1,000 to anyone else. Only applies to one marriage per person unfortunately.
• gifts to charities - Any gifts to charities are exempt from IHT

There are also currently what are called Potentially Exempt Transfers (PETs). Most gifts in excess of the exemptions given above made during your lifetime are exempt at the time that they are made, but are subject to your surviving for seven years after the gift was made. If you survive the full seven years than there is no liability to IHT. If you die within this period of time then IHT will become payable. It may be at a reduced rate, but this only takes effect if you have given away more than £300,000 within three to seven years of your death. Here is a table which details the reduction in IHT on gifts made within 7 years of death.

Finally you should consider using trusts to avoid paying IHT. We have explained a little more about trusts below. 

What is a Trust?

Trusts are a very useful, if sometimes complex, legal way of giving your money, property or shares, to others, whilst ensuring that you, or others that you trust (hence the name), retain some control over what happens to those assets. They are frequently used to avoid paying unnecessary Inheritance Tax, or for helping to solve long-term family or domestic situations, such as giving money to children or grandchildren, but at an age when they can be considered to be responsible.

You can create a trust while you are alive, usually by a formal trust deed. This is usually referred to as a "settlement", or you can create a trust on your death in your Will (a "Will Trust"). Whichever method is used the document will set out what is being given away, who is going to look after it (the "trustees" - who can include yourself in lifetime trusts), who is to benefit from the gift (the "beneficiaries"), and any rules that the trustees must follow when looking after the assets - for example what they can and cannot invest in; how the capital and income can be spent; and how long the trust is to go on for.

Before setting up any trust you should seek the advice of a trust expert. There is an organisation called the Society of Trust & Estate Practitioners, who can provide you with a list of their members in your area - simply telephone 020 7838 4890 or e-mail step@step.org. They have a new website at www.step.org. Their members come from the legal, accountancy, corporate trust, banking, insurance and related professions, and are involved at all levels in the planning, creation and management of, and accounting for, trusts and estates, executorship, administration and related taxes. Of course this means they are also experts in will-writing, probate and EPAs and not just trusts.

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