Avoiding inheritance tax * reduce IHT * writing a Will * discretionary trusts * avoiding inheritance * tax calculator * advice * specialists * beneficiaries * exemptions * tax bands

With the way that property prices have risen in the UK, many people are likely to have an inheritance tax problem. Avoiding Inheritance Tax is therefore an important issue. Let's face it, you only have to own a garden shed in Wapping and you have gone through the inheritance tax (IHT) threshold. Stick in a fork and spade and a half decent lawnmower and your beneficiaries will have to sell the garden shed to keep your gardening gloves. I exaggerate of course to make my point but simply by a properly drafted tax efficient writing a will, you can reduce your IHT liability.

AVOIDING INHERITANCE TAX

Before we discuss how to avoid inheritance tax, we need to understand what the Inheritance Tax problem is really all about.

As pointed out elsewhere on this site, inheritance tax is payable on a deceased estate valued at over £300,000 (at the time of writing), but transfers of property on the death of a partner between a husband and wife are exempt.

The problem is, having spent a lifetime paying and complaining about the amount of tax they pay; most people actually end up wasting this tax exemption.

For example:

Mr and Mrs Barrow jointly own a house and other assets valued at £500,000. Assuming they own everything 50:50, each partner is worth £250,000 which is less than the current Inheritance Tax threshold of £300,000.

Understandably you may believe that they do not have an inheritance tax problem. Think again.

Theoretically, if both Mr and Mrs Barrow died simultaneously and each of them left their £250,000 to their children, then there would be no Inheritance Tax to pay. This is because each of them has an IHT free allowance of £300,000 and each of them has an estate worth less than that figure.

An unselfish act to depart in that way but of course, in reality, it is unlikely that Mum and Dad will die together. What's probably going to happen is that one of them (let's say Dad) will die first and then Mum will die at a later date.

REDUCE IHT

Let's assume for the moment that Mr Barrow has not done any inheritance tax planning and so his will simply leaves everything to his wife or, if she has predeceased him, his children.

So, Mr Barrow dies and his £250,000 passes to his wife. There is no Inheritance tax to pay because a transfer between spouses is exempt from inheritance tax. Mrs Barrow now owns the whole estate of £500,000 (her original £250,000 plus the £250,000 she has now inherited from her husband) outright.

That means that when she dies and leaves everything to her children, she has an estate of more than £300,000 and so Inheritance Tax has to be paid on the balance. In this example, the Inheritance Tax payable amounts to 40% of £200,000 which is £80,000. (NB - for simplicity, this example assumes that the Inheritance Tax threshold has not changed since Mr Barrow died a few years earlier and so is still set at £300,000 and the estate has not increased in value).

By leaving his share of the estate to his wife when he died, Mr Barrow did not need to use his £300,000 inheritance tax exemption - the so-called nil-rate band. What would be nice is if Mrs Barrow could therefore have approached the taxman when Mr Barrow died and said "My husband just died and left everything to me, so he didn't use his nil-rate band. Please can you combine his unused allowance with mine when I die, so as I am able to leave up to £600,000 to my children without incurring an inheritance tax bill?"

Unfortunately with the inheritance tax nil-rate band, it's a case of "use it or lose it". That's why Mrs Barrow only gets to use her own £300,000 allowance when she dies and leaves everything to the children and that's why we said at the start of this article that most people end up wasting their inheritance tax allowance.

So, how could the Barrows have avoided wasting Mr Barrow's nil-rate band Inheritance Tax allowance when he died?

AVOID INHERITANCE TAX

In general, there are two things they could have done. For either option to work, they would have had to first make sure that they owned their house as tenants-in-common rather than as joint tenants. More information on tenants in common can be found on our page about severing a joint tenancy.

The first option would have been for Mr Barrow to leave his half of the £500,000 worth of assets to the children. This will have meant that he was willing his £250,000 share of the estate to his children which would have been free of Inheritance Tax because it was less than the Inheritance Tax threshold of £300,000.

His nil-rate band allowance would not have been wasted by this action. There would have been no Inheritance Tax payable when he died and, when his wife died and left her share of the estate to their children, there would still have been no inheritance tax to pay as she would only have been leaving £250,000 as well.

This all seems simple and straight forward but there are potential problems. The drawback is that now she is a widow, Mrs Barrow is living in a house that is owned jointly by her and her children. This is not an ideal situation, as it means her children could try to force her to sell the house if they want to get their hands on the money that is tied up in the property or even spend any cash that was a part of the estate.

No one likes to think of their children doing anything that is not in the interest of their parents, but circumstances can change and a child can feel they are acting in the interests of the remaining parent.

A much better alternative is to use something called a nil-rate band discretionary trust. With this option, Mr Barrow would have left his £250,000 to a discretionary trust instead of to his children. Mrs Barrow would have been able to have access to the trust fund during the rest of her life and then, when she died, the trust would have paid out to the children.

The children would therefore have inherited £250,000 from the trust and £250,000 from Mrs Barrow and there would have been an inheritance tax saving of £80,000 based on the IHT rate remaining the same and the estate not increasing in value.

To find out more about inheritance tax planning, please see our article about avoiding inheritance tax with nil-rate band discretionary trusts, or click here to get some advice from a qualified inheritance tax planning consultant.