London: The younger couples marrying to beat inheritance tax
18 February 2014
Posted by: Author: Richard Dyson
Author: Richard Dyson
A younger generation is waking up to the dangers of inheritance tax, jolted by the recovery in the housing market and the fact that the inheritance tax threshold – above which the value of an estate is taxed at 40pc – is to be frozen for the next five years and possibly longer.
In some cases the fear of death duty is encouraging couples to marry (see report, below). Because spouses and civil partners can inherit assets tax-free, marriage is an increasingly valuable way of protecting a partner from a tax bill which, in the worst outcome, might force the sale of their home.
The average property in London is now priced at more than £430,000, according to the Government’s own figures. This sum exceeds the individual IHT threshold, set at £325,000, by one third.
The £325,000 threshold is set to remain until 2018, the Government has indicated, while nationally house prices are predicted to rise by 25pc in that time. If those scenarios play out, the average property in the majority of regions will reach the IHT threshold.
Awareness of the thresholds and the basic rules of IHT is low, but growing. Research by Close Brothers, the investment group, into a pool of respondents whose assets exceeded £325,000 found that half were aware of the threshold.
The majority of people – eight in 10 – were also aware of the seven-year gift rule, which enables assets to become exempt from inheritance tax if the donor survives at least seven years after the gift was made.
There are other ways of reducing a potential IHT bill.
The joys of marriage
Marrying or forming civil partnerships does not only ensure that a couple can bequeath assets to each other tax-free. They can also pass on the unused element of their allowance to their spouse, so that the ultimate beneficiaries of that spouse’s estate – usually a couple’s children – can benefit when he or she dies.
This change to the IHT rules was introduced in 2007, and the immediate effect was to double the sum that a married couple could bequeath on both their deaths. It can be applied back to spouses who died at any time after October 9, 2007.
There is another less obvious perk in the way the allowance is transferred. The value of the allowance itself at the death of the first spouse does not matter. Instead, it is the percentage of the allowance unused which is carried across to the surviving spouse – and applied at the current value of his or her later death. In other words a husband dying today and bequeathing everything to his wife would use none of his current allowance. So if, when his wife died, the allowance had been pushed up to £500,000, he could add 100pc of his allowance to hers, making a total £1m exemption.
The importance of planning and giving
By adopting the "little and often” approach to giving, donors can remove a lot of money from their estate without having to survive seven years. You can give £3,000 each tax year, plus up to £250 per year to an unlimited number of individuals. Other gifts – unless you have sufficiently large incomes to claim they are gifts made out of "surplus income” – will be treated as "potentially exempt”, and fall within the seven-year rule.
Gifts and legacies to charities and political parties are exempt from IHT, whenever they are made.
Don’t forget pensions and Isas
A lot of estate planning is not made until late in life. "Our clients tend to think about these issues only when their children have flown the nest and they are in their 60s or 70s,” said Patrick Haines of Close Brothers. By that stage many people have pension assets and Isas, as well as property.
Investments held inside Isas, while free of capital gains tax and further income tax during their owner’s life, are part of their estate and so subject to IHT on death.
But "unvested” pension assets (money not yet turned into pension income) can be kept out of an estate for tax purposes.
Stephen Womack of David Williams Chartered Financial Planners explained: "The value of any pension that is unvested money normally sits outside your estate. The pension trustees decide who gets the money if you die early, which is normally your spouse, so no tax is due on your death, but then this money ends up sitting in the partner’s estate and on their death can trigger a bigger bill.”
In such cases he recommended the use of a "spousal bypass trust” which means that "on your death the pension money goes into a separate trust, with the spouse as one possible beneficiary, but without the assets actually falling within their estate”.
Property is trickier
Mr Haines said: "Given the range of solutions, anybody with an IHT liability is likely to be able to do something to reduce it. But a lot depends on how it is structured.”
Wealthy families with many types of asset – shares, cash, or several properties – have more tools at their disposal than more ordinary, middle-class families whose single biggest asset is likely to be the home they live in.
"If most of it is in bricks and mortar the options are limited,” said Mr Haines. Riskier choices could be to borrow against the value of the property, with the proceeds being given to beneficiaries; or, more simply, to insure against IHT by taking out life insurance held in trust. The proceeds of the policy are outside the estate and are earmarked to cover the tax bill.
'We wed for tax purposes'
Is "estate planning” – the process of trying to limit inheritance tax – the preserve of the very old and rich? Apparently not.
Rising house prices in London and elsewhere have younger cohabiting couples fretting about the possible impact of this controversial duty.
Jim Poulter, 48, a marketing executive, (pictured above) thinks of himself as "not especially well off”. He has built up some Isa investments and has death-in-service benefits through work which would pay out on his death. The bigger problem is a modest home in south-east London, which is worth considerably more than the individual IHT allowance – or "nil-rate band” – of £325,000.
"When you are in your 20s your assets probably amount to a surfboard and a pushbike,” he said. "But it mounts up when you own even an ordinary property. I’m not keen on avoiding tax, but thinking recently about writing a will was a catalyst.
"We saw that marriage was a sensible option – we decided to get married quickly and without too much fuss while we were holidaying in the US. There’s a fine line between being sensible and going all out to avoid tax.”
This article first appeared on telegraph.co.uk.