Inheritance Tax

The rules for inheritance tax are briefly as follows...

We all have a nil rate band, assets up to the value of this band are not included when calculating Inheritance Tax. For 2010\2011 the nil rate band is £325,000. Essentially, if your assets are worth less than the nil rate band then there is no tax payable on your death.

If your assets are worth more than the nil rate band then tax on the difference is calculated at 40%. For example, if your worldwide assets are worth £525,000 then we subtract £325,000 to leave £200,000 which is taxed at 40%. The tax payable in this example would be £80,000.

To avoid inheritance tax there a few rules that we can benefit from...

 The first is that we can transfer all of our assets to a spouse or civil partner free of inheritance tax. Our nil rate band will also transfer to the spouse or civil partner effectively granting them a nil rate band of £650,000. On their death, assets worth up to £650,000 will not be taxable.

The second is the ability to give assets to other people. If you do this then you must derive no benefit from the asset - for example, you cannot say you have given away a painting and leave it hanging on your wall. Gifted assets will still be included in the value of your estate for seven years; the first 3 years at 100% of value then sliding in value until, after seven years, it is no longer chargeable. Certain gifts do not fall into the seven year rule...

• Wedding gifts of up to £5,000 to each of your children (including step-children and adopted children) or the person that your child is marrying
• Wedding gifts up to £2,500 to each grandchild or the person that your grandchild is marrying
• Wedding gifts of up to £1,000 to anyone else
• Payments for the maintenance of your husband or wife, ex-husband or ex-wife, dependent relatives and, usually, your children who are under 18 or in full-time education
• Other gifts up to a value of £3,000 in any one tax year, plus any unused balance of £3,000 from the previous tax year (The tax year starts on 6 April in one year and ends on 5 April in the following year.)
• Outright gifts in any tax year up to a total of £250 each to any number of people, but only if the total of all gifts made by you to the recipient in the same tax year does not exceed £250.
• You can make gifts under more than one of the above headings to the same person and they will be free from inheritance tax. For example, to a child in the year they marry, you could give £5,000 as a wedding gift plus £3,000 as another gift, and these would be exempt.

So, why would you consider life assurance to help with inheritance tax?

You need only consider life assurance when assets are worth more than the nil rate band and you are not prepared to sell an asset to pay the tax. A good example is where the family home makes up the majority of the estate's value and you do not want to sell it following the death of your parents.

For example, an estate worth £1.15m is made up of a home worth £1m and other assets worth £150,000. Assuming the survivor inherited the nil rate band of their spouse\civil partner then the first £650,000 is not taxable. The remainder, £500,000, is taxed at 40% leaving a tax bill of £200,000 to pay. After the house there is only £150,000 that could be used to pay the bill, this is not enough and there may be valuable items that you might also wish to retain. Your choice is to sell the house or insure the life's of your parents for £200,000 on a joint life second death basis using a whole of life plan. *IMPORTANT* the benefits must be written in trust so they fall outside of the estate otherwise the life assurance will add to the problem by raining the tax a further £80,000.

A similar solution is available whereby gifts have been made within seven years of death that could also attract an IHT liability. In this case a reducing term assurance policy for 7 years would be the answer. Again, the policy must be written under a trust.