The IHT legislation is complex, with many rules, exceptions, and reliefs. Expert inheritance tax planning advice is needed to ensure maximum benefit from these. This article highlights ways to reduce your tax burden and the pitfalls of failing to seek professional help from financial advisers.

Gifting your home to children

The family home is often the most valuable asset an individual owns, so many people believe it is where to start IHT planning. This is especially true for properties worth over £175,000, the current residence nil rate band.

However, not taking financial advice in this area can lead to unintended, unwelcome, and potentially expensive tax consequences.

Most taxpayers are aware of the seven-year rule that if you give an asset away and survive the gift by seven years, the gifted asset is no longer considered part of your estate for IHT. An outright gift is a Potentially Exempt Transfer (PET), and a great way of saving IHT as you can give away substantial assets to reduce the IHT payable on your death.

However, PETs are subject to strict rules. If you make a PET and retain any benefit in the asset you have gifted, the PET fails, and the asset will be treated for IHT purposes as though it was never given away. This is called a Gift with Reservation of Benefit (GWR).

Therefore, if you give your home away and continue to live there as you have before, the GWR rules will apply to the gift and the full value of the property will remain in your estate for IHT purposes.

If you wish to save IHT by giving your home away and continuing to live there, you will need to pay market rent to the recipient, usually your children. This will exclude the home from the GWR rules, but you will still have to pay rent to live in your home. The gift recipients will have to declare and pay income tax on the rental income they receive from you. You will also have to continue paying the bills.

As an aside, the gift will be recognised for all other taxes. This could lead to unexpected capital gains liability on the sale as it is unlikely to have been the new owner’s primary residence unless they are cohabiting with you. They could also be liable for higher rates of SDLT should they purchase other residential property.

Despite the above, there are certain circumstances in which gifting the family home or a share of it can be effective tax planning. Still, careful consideration of the pitfalls above must be given.

Unmarried couples

Many couples do not realise that only married couples or those in a civil partnership can pass assets between them without worrying about IHT. Even if an unmarried couple has lived together for many years, if the first person to die leaves their estate to their partner, 40% IHT will be payable on the value of assets over the first £325,000. This is particularly unfortunate if the family home is the most valuable asset and the estate has insufficient cash to pay the IHT due. Whilst it may be possible to pay any IHT due in 10 yearly instalments, the surviving partner may face the prospect of having to sell the family home to pay the IHT bill.

Not writing life assurance policies in trust

Many people take out life insurance policies to help loved ones after their death. The policy can provide funds to pay any IHT due or simply ensure those left behind do not experience financial hardship. But if you have life policies, have you written them into trust?

If a life policy is not written into trust, the policy proceeds will be paid into your estate and could be subject to IHT.

Life assurance companies generally offer the option of writing the policy into trust at no extra charge, or your solicitor can draw up a trust deed for you, and it is possible to put any existing policies into trust after you have taken them out. Checking whether your insurance policies are written in trust could save you many thousands of pounds in IHT.

Another advantage of writing life policies in trust is that the proceeds do not have to pass through probate. Therefore, the money is available to the executors before probate is granted. The proceeds can be used to pay the estate’s inheritance tax and other liabilities and to provide for any specific bequests.

Disregarding other effective inheritance tax planning strategies

There are plenty more ways to reduce your potential tax liability, including the following:

• Business relief, which reduces the value of a business and its assets for the purpose of IHT
• Regular gifts, which you can make from your surplus income up to the annual exemption of £3,000 each in the tax year
• Chargeable lifetime transfers, which occur when individuals make a gift that is not outright — like into a flexible or discretionary trust, for example
• Gifts to charity, political parties and national organisations, which are tax-free during your lifetime and in your will
• Trust funds, which are legal arrangements that hold your assets in trust for the benefit of a named third party

These have plenty of pitfalls, too, which is why it’s important to seek the help of experienced advisers when estate planning.

Don’t leave IHT planning until it’s too late!

It is easy to leave IHT planning for another day, as life is hectic and other more immediate demands take up your time and attention. However, taking advantage of IHT planning early can ensure that you do everything possible to mitigate your family’s potential IHT exposure and maximise family wealth. Put simply, the earlier you start to make gifts, the more chance there is of surviving them for seven years.

Taking professional advice can help you avoid the above pitfalls, make plans that benefit you, the people and causes you care about, and minimise the IHT payable on your taxable estate. We would be happy to review your IHT position and assist with an inheritance tax planning strategy to mitigate potential liabilities.

For a better understanding of Inheritance Tax, please read our quick guide to inheritance tax by Oliver Dorrington.

This article is from the latest edition of our A Matter of Tax newsletter. To receive future copies of any of our newsletters directly to your inbox, please visit our preference centre to register your interest.