INHERITANCE tax (IHT), which once hit only the very wealthy, is now a problem for one in three households, new research has revealed.
Scottish Widows, the insurer, claims that 8.2m people, or 34% of homeowners, are at risk from the tax, and most are doing nothing to cut the bill.
“IHT is paid by only 6% of estates” said Anne Young at Scottish Widows. “But the rapid rise in house prices has pushed millions more above the threshold without them knowing it.”
Two schemes were launched last week that claim to help you escape the burden. The plans from Norwich Union International and Standard Life International are a type of discounted gift trust. These enable you to give away assets from your estate to cut IHT but still draw a regular income.
This type of trust escaped a crackdown by Gordon Brown last year. The chancellor closed a loophole through which homeowners had been able to shelter their assets from IHT while continuing to benefit from them. However, discounted gift trusts, along with several other schemes, were excluded.
Young said: “Some schemes emerged unscathed from the crackdown on pre-owned assets. The Revenue looked at them fairly comprehensively at the time and on that basis they are probably fairly safe, even if the government widens the anti-avoidance net.”
Heirs must pay 40% on anything above £275,000, including the value of the family home. More people have been dragged into the IHT net because the threshold has failed to keep pace with house prices. The government has increased it each year in line with retail-price inflation, but this has risen at a much slower rate than house prices.
Since May 1997 when Labour was elected, the IHT threshold has risen 28%. In the same period, house prices have soared 152%, according to the Halifax index. If the two had gone up in tandem, the threshold would now be £541,800.
Discounted gift trusts are designed for people who do not need access to their capital and want to pass it to their heirs free from IHT. But they also want to retain the right to draw a regular income.
You make a gift into a single-premium insurance bond for your children, fixing how much income you draw until your death. If you survive for seven years, the bond does not count as part of your estate. Your heirs keep any growth in the bond as well as what remains of your investment.
Even if you die within seven years, your heirs may get a discount on the IHT because your right to draw an income from the gift reduces its value. The extent of the reduction depends on your age, health, gender and level of income.
If you are male, 70, and draw 5% a year from a scheme, about 45% of the trust’s assets could fall out of the estate as soon as a gift is made.
Some advisers have been reluctant to recommend such schemes in the past because the underlying investments — insurance bonds — often perform poorly.
The average UK equity insurance fund is up 73% over 10 years compared with the average unit trust in the same sector, which is up 103%.
But Norwich Union International claims to have overcome this by allowing investors access to more than 1,500 funds from a diverse range of managers, including those running unit trusts. It claims that almost any investment fund can be added to the bond.
There are other effective ways to cut IHT. A married couple can make their home more tax-efficient by setting up a discretionary trust. This ensures they both make use of their nil-rate tax bands. Rewrite your will to leave £275,000 worth of your home to a discretionary trust set up for your spouse and children on the first death. If the husband dies first, the house passes to his wife and she can continue to live in it, but she owes the trust £275,000. When she dies, this debt is deducted from her estate.
Loan trusts from insurers can also save IHT. They give you more flexibility than a discounted gift plan but are more complex.
HOW DISCOUNTED GIFT TRUSTS WORK
Say you had an estate worth £1m, half in property and the rest in cash and shares — £725,000 above the inheritance-tax (IHT) threshold of £275,000.
You could buy a discounted gift trust from an insurer and pay your £500,000 of cash and shares into the trust for your heirs. It would be invested in funds run by the insurer, which might have annual charges of 3%. You would retain the right to draw an income from the money.
The gift would be classed as a potentially exempt transfer and as such would be free from IHT as long as you lived for seven years. Any investment growth would also be free from tax. Even if you lived for less than seven years, your heirs could save IHT because the fact that you retain the right to draw an income reduces the value of the gift.
The exact saving depends on your age, health, gender and income. If you are male, 70, and draw 5% a year, about 45% of the trust’s assets could fall out of the estate immediately. So if you made a gift of £500,000, only £275,000 would be subject to tax — an IHT saving of £90,000.
BILL THREAT
NICKI MARSH, 40, doesn’t think of herself as particularly wealthy but like millions of other homeowners she is facing the prospect of an inheritance-tax bill.
Nicki, a housewife, and her husband, Philip, a dentist, own a property in Teddington, Middlesex that has pushed them over the tax threshold. The couple have two sons, Jack and Ted.
Inheritance tax is a particular problem for homeowners like the Marshes who live in the south of England because this is where house prices are highest.
Insurer Scottish Widows claims that nearly four in ten homeowners in the south of England are now liable for IHT. In London this rises to two-thirds.
‘Everyone who lives around us and all our friends are in the same boat,’ said Nicki.
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