IHT-efficient family
Tax legislation contains some complex rules intended to stop you avoiding tax by shifting income or assets to your family. But there’s one area in which this is positively encouraged. What is it?
The importance of planning
For many people, avoiding Inheritance Tax (IHT) isn’t high on their agenda, yet if the worst happens it can hit your family hard by taking up to 40% of your wealth and turning it over to the Taxman. Fortunately, there are plenty of ways to legitimately escape the tax net; often this is achieved using IHT exemptions and reliefs to shift wealth out of your estate, usually onto the next generation. But some of these tax breaks are devilishly tricky to use.
Tax breaks
IHT breaks fall into three main types: exemptions, reliefs and exclusions. Most people have heard of the annual and various other gift exemptions, and you’ve probably heard of the reliefs for business and agricultural property, but what are “exclusions”? These simply mean gifts from you to someone else that are completely ignored for IHT. Therefore, you don’t need to consider whether an exemption or relief will apply as it doesn’t count as a transfer in the first place. One such exclusion is the so-called “dispositions for family maintenance”.
Family maintenance
S.11 of the Inheritance Taxes Act says that where you make a gift to certain members of your family it will immediately cease to be part of your estate for IHT purposes where it’s intended for their maintenance. It applies to gifts to:
• your, or your spouse’s, children as long as they are under 18 or, if over, in full time education
• your, or your spouse’s, parents
• any relative of yours, or your spouse, that is dependent on you for care.
How could this tax break work in practice?
Child’s education
Let’s say that you want your child to go to a private school. You could pay the fees as you go along, or you could make a gift to your child earmarked for their maintenance and education over the years. You would need to put the money or assets in trust (see The next step) as a child can’t own them in their own name. If the worst happened to you a few years later, the Taxman would exclude the money in the trust from the IHT charge. Whereas if you had kept it in your bank and just paid the school fees as you went along, it would remain part of your estate and so be subject to IHT.
Elderly parents
Another use might be where you pay for care for your elderly parents, e.g. nursing home fees. The principle is similar to the school fees arrangement except that the gift could be made direct to the parents rather than put into trust. The key is to shift the capital from your estate in a lump sum rather than pay the fees as you go along, so it ceases to be part of your estate straightaway.
Trap. Not all gifts count.To qualify for the immediate exclusion from IHT, the gift must be for the maintenance of your relative, that includes education where it’s for a child.
Tip. If you aren’t going to use a trust to hold the money, then always have the arrangement backed up by other documentary evidence, say, an exchange of letters with the relative concerned. And send a copy to the executor named in your will.
For more information on trusts, visit http://tax.indicator.co.uk(TX 10.16.07).
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