e-mail Paul Lewis on paul@paullewis.co.uk
Married couples can save their children tens of thousands of pounds in inheritance tax if they take a couple of simple steps now. It will not cost them anything and the risks are small. All they have to do is split their property and in effect double the amount they can leave without paying tax to half a million pounds.
Inheritance tax used to be a worry only for the rich. But now while the very wealthy seem to avoid it routinely – none was paid this year on the estates of the Queen Mother and the Duke of Argyll – people with quite ordinary amounts of money are caught.
The chances of paying inheritance tax have grown recently. In 1996/97 inheritance tax brought in just over £1.5 billion from 15,000 estates – less than 3% of the people who die each year. This year it will hit 24,000 estates and bring in £2.5 billion. One reason is the rapid rise in house prices. The average house in the UK is now worth £115,000 and in London, £200,000. And the tax starts at £250,000. If house prices continue to rise, so will the numbers paying inheritance tax. The level at which the tax starts to bite rises each year roughly in line with the rate of inflation, currently less than 2% a year. But house prices are rising ten times as fast, bringing more and more estates into the inheritance tax net. If inheritance tax had risen in line with house prices since Labour came to power in 1997, it would now start at £400,000 saving thousands of people anxiety – and their children half a billion pounds.
If the total you own in cash, investments, property and belongings is less than £250,000 then you need not worry about inheritance tax. If you leave more than that then your heirs will have to pay 40% of the value above £250,000. For example on an estate worth £350,000 your heirs will have to pay £40,000 tax.
Couples
Couples who own property jointly are in a better position to save tax than people living alone. That is because inheritance tax is assessed individually. So a couple get twice the allowances – if they are careful and separate their property while they are still alive.
Many couples think they do not have to worry about the tax before the first partner dies because anything left by a husband or wife to their spouse does not attract inheritance tax. But that is a mistake. When the first spouse dies no tax is due on whatever their husband or wife inherits. But when the second spouse dies tax is due on the whole estate. So it is better for the first spouse to leave property to other people using up their own tax-free limit of £250,000.
Mary and Mike Smith own a house worth around £200,000 and have investments, and some cash worth another £200,000. Mike dies after a long illness and leaves everything to Mary. As his wife, she pays no tax. But just a year later Mary dies too, leaving the £400,000 estate to her two children, Tim and Jane. The first £250,000 is exempt from tax but the rest is taxed at 40% leaving her children with a tax bill of £60,000. But if Mike had made a will leaving the house to Mary but the rest of the property to the children, then no tax would be due when he died – the property left to his wife is free of tax and the value of what he leaves to the children is within the £250,000 tax-free band. When Mary died she would leave the house to the children which is also below the £250,000 limit and free of tax. So their children would inherit everything in two stages without paying any inheritance tax – saving £60,000.
There are drawbacks with this plan. First, the investments left to the children will no longer benefit their mother. That is because the gifts must be absolute. Tim and Jane pass the income on to Mary. But as they both pay tax, Jane at the higher rate, the income from the investments is reduced. Tim is also concerned that if he loses his job he will not be able to claim any means-tested benefits from the state while he has £100,000 in the bank.
The plan can also work even if most of the assets are in the family home. The first thing to do is to divide the ownership of the house. Many couples own their home as what are called ‘joint tenants’ (‘joint owners with survivorship’ in Scotland). When one dies the other simply becomes the owner of the property without formality. There is a different way of owning a home called ‘tenants in common’ (‘joint owners’ in Scotland). Under this form of ownership, each partner owns a stated share of the property – usually half. It is simple to change to this form of ownership. Each spouse writes a letter to the other saying that in future the property will be owned as tenants in common in equal shares (in Scotland see a lawyer).
Each then makes a will leaving their share to their children. When the first partner dies the children inherit that share of the home. They then agree to allow the surviving parent to carry on living there – that must not be a condition of the will. When the second parent dies the children inherit the rest.
Stanley and Ethel own a home worth £400,000 as tenants in common and very little else. Stanley dies, leaving his half of the house equally between their three children James, Matthew, and Elizabeth. Ethel carries on living there until she dies and the children inherit the rest. No tax is due on either death and the children save £60,000 inheritance tax.
There are dangers. All the children are joint owners of the home and any of them could insist it be sold at any time. If any of them divorces or goes bankrupt then the courts could order the house to be sold to realise their share. And if any of them claimed income support or another means-tested benefit, owning a share of the home could prevent them from doing so.
It is vital to make a will to ensure that your wishes are carried out. However, if you do not put proper inheritance tax avoidance plans in your will, then your family can effectively rewrite it after death provide they do so within two years of the death and provided all the beneficiaries in the will agree. It is called a Deed of Variation and is best done by a lawyer.
Giving it away
The easiest way to avoid inheritance tax is to give everything away and live for seven years. Any gifts made at least seven years before you die are completely exempt from inheritance tax. However, you have to be careful using this rule. If you give something away and still retain the use of it, then it is counted for inheritance tax as if you still owned it. For example, if you give your home away to your children and continue to live in it (and they don’t), then the value of the home will still count as part of your estate. The Inland Revenue calls it a gift ‘with reservation of benefit’. You can get round this rule by paying your children the market rent. But you may not have the income to do that and they will have to pay tax on their profit and possibly capital gains tax when they eventually sell the home.
Some people do not have to pay inheritance tax at all. If the person’s death was due to active service in the armed forces – or was hastened by it – then the whole estate is completely exempt from inheritance tax. Also completely exempt is anything left to a registered charity or to one of the nine political parties which have at least two MPs in the UK Parliament.
You are also allowed to give away up to £3000 each tax year without it counting as part of your estate even if you do die within seven years. A husband and wife can give each £3000 a year, and if you gave nothing away in the previous tax year then you can double that. So a couple who gave away nothing last year, can give £12,000 this year without counting as part of their estate. It is safest to give cash. If you give shares or property which have grown in value while you owned them, then capital gains tax may be due.
You can also give away any number of small gifts, up to £250 each, to any number of separate people. You can give up to £5000 to a child of yours when they marry – and up to £2500 to a grandchild (or great-grandchild) or £1000 to anyone.
If you have a high income and you give away part of that, without reducing your own lifestyle, then that is also exempt.
Inheritance Tax
|
Estate value |
Tax due |
% of total |
|
£250,000 |
£0 |
0% |
|
£300,000 |
£20,000 |
7% |
|
£350,000 |
£40,000 |
11% |
|
£400,000 |
£60,000 |
15% |
|
£500,000 |
£100,000 |
20% |
|
£600,000 |
£140,000 |
23% |
|
£750,000 |
£200,000 |
27% |
|
£1,000,000 |
£300,000 |
30% |
December 2002
e-mail Paul Lewis on paul@paullewis.co.uk