They say tax and death are the only two certainties in life - but this year UK taxpayers will waste more than £1.3bn due to poor inheritance tax (IHT) planning. And this figure is rising, fast. In 2012 £24m more was left out for the circling tax vultures to feed on than in 2011, according to the latest annual Tax Action Report from Unbiased.co.uk.
Planning ahead to protect your estate from HM Revenue & Customs is a complicated business, but doing so has never been so important. This is because the government has bitten off a third of the value of inheritance tax reliefs - leaving us with less because they have failed to raise the allowance in line with inflation.
By freezing the threshold at £325,000 per person for the foreseeable future, it has delivered a painful blow to savers and their relatives.
But you haven’t spent your life saving and investing to let the taxman have first dibs on your nest-egg. If you want to maximise the wealth you can pass on to your family when you die, some careful planning is essential if your estate is worth more than the threshold of £325,000 (or £650,000 for a couple), below which you won’t be taxed.
Give away the right amount
The first thing you should do is decide how much you want to give away. For many people the aim of this exercise is to give away as much as possible. But you don’t want to give away so much that you run the risk of having to ask for some of it back one day.
There is a huge list of reasons why you might suddenly need more capital when you get older, but the single biggest threat for most people is the unforeseen cost of long-term care. Despite one in three of us ending up in a residential care home, the majority have no realistic idea of how much care costs, which makes proper financial planning impossible. Research from care annuity provider Partnership found two-thirds (65 per cent) of adults think care home fees are less than £30,000 per year, a third think they won't exceed £20,000 and 12 per cent are under the impression they are less than £10,000.
But care home fees are actually on the rise and will set you back around £30,000 per year, on average, with rooms in nursing residences located in London and some areas in the south-east well in excess of £40,000 a year. The average duration someone will spend in a care home is 800 days (around two-and-a-half years), according to Bupa, but up to a quarter of people will need care for as long as a decade.
Protect yourself from IHT and running out of money
Luckily though, there is a way you can protect some of your estate from inheritance tax while having the comfort of knowing you can get some - or all of it back if you need it. When you put a chunk of your money in a Loan Trust Scheme it enters a wrapper that protects you and your beneficiaries from IHT on any growth on that sum. But practically speaking - the money is still yours because you can withdraw cash from the scheme whenever you like. So, if you think there's a chance you might need to get your hands on your money again - this provides a solution. The money is invested how you choose - but the deal is that your beneficiaries only receive the growth (sometimes capped at 5 per cent) until you die, and then the original loan (or whatever is left of it) goes back into your estate and is subject to IHT.
Ian McNally, director at Saunderson House, says because the set-up costs are anything from £750 to £1000, this is only really a viable option for a sum of £50,000 or more.
A Discounted Trust is another option that allows you to take income from your wealth at the same time as protecting it from IHT. When you put your money in, you are giving it away as a gift - but it is invested on the premise that you will take a decided level of income from the capital (and from the growth if there is any). The benefit is a chunk of your gift is "discounted" from IHT - the older you are the bigger the discount is. Around 40 per cent of a 60 year old's gift will be subject to IHT, while a 90 year old could give more - up to 80 per cent of the gift can be given IHT free - even if they die within seven years. And if the gift amount is under £325,000, and you haven't used up your IHT allowance elsewhere in your estate, your whole gift won't be taxed when you die. You can set up a new discounted trust every seven years but they are irreversible, and they cost around 1 per cent plus investment charges. Because of this they are only really cost efficient for sums of £50,000 or more.
What advantages do these Trusts have over standard gifts?
Simply giving money away in the shape of a gift is one of the most common solutions for reducing IHT bills. While there are several annual allowances for small gifts, giving larger amounts away is not so simple.
If you die within seven years of giving a large sum away, the taxman will reclaim IHT (40 per cent) of its full value. So if you’re still relatively young and confident you'll live that long a gift might be a good idea. The disadvantage with the Loan and Discounted Trusts is the charges - which will eat away at your money the longer it is stored in the arrangements. And your gifts won't escape IHT unless they come out of your regular income (not out of your entire wealth). They also have to be regular and they cannot be so big they diminish your standard of living. For example if you earn £100,000 a year and normally spend £70,000 on outgoings, and one year you decide to give £99,000 away to your daughter, even though this may be a gift out of your income the gift won't qualify for IHT relief.
So if you’ve got a large estate, the best way to protect as much as possible from IHT might be to use a combination of solutions.
Other IHT minimising ideas
Aim shares in your Isa
Come autumn 2013, there will be a new way you can protect a chunk of your estate from all taxes, including IHT - by investing it in certain alternative investment market (Aim) shares through your individual savings account (Isa). Currently Aim shares aren't allowed in Isas but when the new rules are introduced, a couple could use up their joint stocks and shares Isa allowance of £23,040 to buy them. They have to be held for two years before they are exempt from IHT and shares in companies related to investment or property may not shelter your money from IHT - so check before you buy.
Charitable gifting
If you give 10 per cent or more of your estate to charity the rest of your estate will be charged at 36 per cent IHT, rather than the standard 40 per cent rate - making a saving of 4 per cent. You can gift this money at any point, but it’s probably easiest to write it into your will.
