MONEY COMMENT
Homeowners To Inherit Higher Taxes

By Cliff D'Arcy
August 27, 2004

The government is considering a change in the law that could mean people with assets worth more than £263,000 (including their homes) could end up paying a lot more inheritance tax (IHT) when they die. This legislation will have a major impact on countless middle-class families that have created a trust in order to avoid paying IHT on their assets, including the family home.

From next tax year onwards, Gordon Brown wants 'gift and loan' trusts to pay income tax . Hundreds of thousands of people have used these arrangements to shelter cash or assets from IHT, which swallows two-fifths (40%) of assets in excess of £263,000.

Both the wealthy and the moderately well-off use these trusts to minimise the amount of IHT their estate will pay. You could lend, say, £100,000 to a trust, and then withdraw capital of 5% a year (£5,000) over twenty years without paying income tax on this sum. Meanwhile, any interest or growth within the trust is excluded from your estate and can be left to your beneficiaries (for example, your children or grandchildren) without being subject to IHT.

Hence, after twenty years, the capital in the trust is entirely owned by the trust and has no liability to IHT. These trusts are popular with people in their forties or fifties, who have a good chance of living the twenty years required to make the best of these schemes.

However, from next April, all trusts created since March 1986 will be liable to income tax, but what's yet to be decided is the rate that they will pay. Many people consider this kind of backward-looking legislation to be unfair, because it would hit lawful trusts established up to eighteen years ago.

IHT brings in £2½ billion a year to the Treasury, although only around one in twenty estates (5%) currently pays it, However, soaring house prices have dragged around two million households (almost one in ten) into the IHT net.

Nevertheless, there are still many ways to avoid - or pay less - IHT. For example, you could:

• Make a Will, which is the key device for reducing tax bills after your death.
• Set up a Will trust, a so-called 'nil-rate band discretionary trust'. This allows you to distribute your assets in a tax-efficient manner after death.
• Create a 'deed of variation', which enables you to alter a Will to change a deceased's instructions, and could hugely reduce the overall tax owed.
• Put life assurance policies into trust, which means that payouts go directly to the beneficiaries, without forming part of your estate. This avoids IHT and is a lot quicker than waiting for probate!
• Gift money in the form of a 'potentially exempt transfer' (PET). You pay tax on a sliding scale on PET gifts, with no tax payable if you live for seven years after making them.
• Make 'lifetime' gifts of up to £250 each to anyone, and up to £3,000 a year in total gifts to one or more people. Also, regular gifts made from your after-tax income are IHT-exempt.
• Make gifts on marriage: up to £5,000 from a parent, £2,500 from other relatives, and £1,000 from non-relatives.
• Leave some of your estate to charity, which is both philanthopic and tax free!
• Buy a life assurance policy to pay your tax bill when you die.

You can learn more about estate planning and IHT in our Wills and Probate centre. However, please note that this is one area where it makes sense to take expert professional advice, as the issues involved can be very complex!