Many of you wrote to me after my piece in the April Saga Magazine about inheritance tax. So this month I am adding more details to the advice I published then. Some of the original information is repeated here and you can read the original piece here.
Giving it away
Inheritance tax is currently charged on estates worth more than £275,000.
That will rise to £285,000 on 6 April 2006 and to £300,000 for deaths on 6 April
2007 or later. If an estate is worth more than that then the tax is 40% of the
excess.
Anything you give away is exempt from inheritance tax as long as you live at least seven years from the date of the gift. There is no point in giving something away if you continue to benefit from it because inheritance tax will still be due on the value of the property on your death. So you cannot save tax by giving your home to your children but continuing to live there. It is called a Gift with Reservation Of Benefit or GROB – or should that be GRAB!
You can give away up to £3000 each year without it counting at all for Inheritance Tax and if you gave nothing away last year you can bring that forward and give £6000 away this year. The allowance is personal so a couple can give away these amounts each. You can give £5000 to a child of yours on their wedding, £2500 to a grandchild (or great grandchild) or £1000 to anyone. You can also give away £250 or less to any number of people but excluding anyone who gets a gift under another exemption. And you can give away any amount from your income if it does not reduce your standard of living.
If you have life insurance or a pension scheme make sure the payout on your death will be made into trust not to your heirs. That way inheritance tax will be avoided. Your insurer or pension scheme provider can provide the necessary form.
Couples
The £275,000 allowance on death is personal. So a couple should make sure
they use it when the first dies and again when the second goes. Many couples do
not do this and leave everything to each other because gifts between husbands
and wives (or civil partners) are exempt from inheritance tax. But it is much
better for each to make use of the £275,000 exemption by leaving what they can
to other heirs. Otherwise when the second one dies the whole estate will be
liable to tax and if it is worth more than £275,000 the heirs could end up
paying up to £110,000 extra tax.
In April I explained how to reduce the tax by splitting your home so you can leave half each and take advantage of the £275,000 allowance twice. First, you have to make sure you and your partner own it as what is called ‘tenants in common’ (‘joint owners’ in Scotland) with each of you owning half of the property. Most couples own their home in a different way – called ‘joint tenants’ (‘joint owners with survivorship’ in Scotland). In that case neither owns a share they can leave – they each own it all and when one dies the whole property passes to the survivor automatically.
In England and Wales you change from being joint tenants to tenants in common by issuing what is called a Notice of Severance. This is simply a document which one of you sends to the other at your home address saying ‘I hereby sever our joint tenancy of <address> and in future we shall own it as tenants in common in equal shares.’ Make two copies. Write your name, sign and date both and get your partner to write ‘I acknowledge receipt of this Notice of Severance’ and write their name and sign and date both.
You then register the new ownership by sending a copy of the Notice of Severance to the Land Registry with a form called RX1 Application to enter a restriction which ensures that anyone trying to buy the property in future knows there are two owners. You can get the form from www.landgreg.gov.uk or any Land Registry. Staff there will also help you fill in this rather obscure document either on the phone or in person. A guide to severing joint tenancy and completing RX1 is due to be published by the Land Registry early in 2006. There is no fee to pay. In Scotland or Northern Ireland ask a lawyer.
As well as changing the way the home is owned you must also change your wills. First, you must each specifically leave your half of the home to your heirs. Second, you must not make it a condition of the will that the surviving spouse can continue to live there. If you do then you will create what is called an ‘interest in possession trust’ and the taxman will treat that half as if the survivor owned it as well and inheritance tax will be due on the whole value of the home on their death.
There are drawbacks with splitting the home and leaving half to your heirs. If any of them divorces or goes bankrupt the courts could force a sale to pay an ex-spouse or creditors. On the second death, each could be liable for capital gains tax on the growth in value of their share of the home, though that will be less than they would pay in IHT if you took no action. Finally, owning a share of a property may prevent them from claiming means-tested benefits.
You can avoid these problems by setting up a trust but the Revenue has recently challenged that use of trusts. It lost the case but may take it through the courts.
Older widows
A special exemption from IHT applies to the estates of some – but not all –
women who were widowed before 13 November 1974. Whether the exemption applies
depends on how she inherited the property from her late husband. The most
straightforward way to inherit is what the lawyers call ‘absolutely’. She
becomes the owner of the property and can do what she wants with it. Nowadays
this is the normal way for property to be left in a will. The other, more
old-fashioned, way to inherit is called an ‘interest in possession’ in the
property, sometimes known as a ‘life interest’. That means that for the rest of
her life she can live in the family home and have the income from any
investments. But legally she is not the owner of the property. It is owned by a
trust and when she dies the trust will pass the property on to the heirs,
normally of course her children.
The exemption from IHT only applies to widows whose late husband left them a life interest in the property. It does not apply to widows who were left the property absolutely. The law is Inheritance Tax Act 1984 Schedule 6 paragraph 2. You can find out how the estate was left from the late husband’s will. If you no longer have a copy you can get one from the local Probate Registry in England or Wales, the National Archives of Scotland tel: 0131 535 1314 or the Public Record Office of Northern Ireland tel: 028 9025 1318.
Armed forces
If a person’s death was due to active service in the armed forces – or was
hastened by it – then their whole estate is completely exempt from inheritance
tax. That rule was used after the death of the fourth Duke of Westminster in
1967. His family, one of the wealthiest in Britain, successfully claimed his
death from cancer had been ‘hastened’ by a stomach wound he suffered fighting in
France in 1944 and paid no inheritance tax at all. The heirs of many people who
have served in the armed forces – either as volunteers or conscripted – or in
the Royal Ulster Constabulary could benefit from this little known exemption
which has existed for more than 300 years. The law is now s.154 of the
Inheritance Tax Act 1984.
January 2006