Inheritance tax (IHT) planning is often left until later in life when its effectiveness can be greatly reduced. Others may be put off by the potential cost of planning products. But how might a simple family loan arrangement utilising exempt gifts help you?
Give it away
It’s always worth remembering that the simplest way for you to avoid inheritance tax (IHT) is to give away excess wealth at the earliest possible opportunity. Of course, that doesn’t mean that you hand money over to just anyone, although that would work. You’ll want to pass it on to your children, grandchildren, nieces, nephews, etc. The trouble is that if you die within seven years of making the gift, HMRC will treat the money as part of the death estate and charge IHT accordingly. But there are tax breaks you can use.
Exempt gifts
The IHT legislation allows exempt gifts of up to £3,000 per year to be made. There are a few other exemptions, however these are aimed at specific types of exempt gift , e.g. to those getting married, and they don’t add up to much. Plus, while you might be happy to make gifts of a few thousand pounds a year, you may not be as comfortable handing over tens of thousands. It’s the classic IHT dilemma: to get the capital out of the estate you have to give it away, but if you do that it won’t be there in the event of an emergency. And worse still, at least from a tax point of view, is that it’s growing in value all the time and so increasing the potential IHT bill.
IHT freezing
The insurance industry offers a couple of IHT avoidance products: discounted gift trusts, as well as IHT-efficient investment funds. Both do the job of getting money out of an estate and, at the same time, can generate an income for you. But they have drawbacks. Like all insurance products they cost money. The insurance company and your financial advisor won’t be setting the scheme up without fees. A further drawback is that they tend to be inflexible. Once you hand the money over, your committed to the terms of the scheme. Getting money out in case of an emergency can be costly, if it’s even possible.
Alternative
As an alternative to insurance products or making a straight gift to the intended beneficiary, you could give them an interest-free, open-ended loan, which you can then use to buy investments. The income the investment money generates will be part of the estate for IHT purposes and not yours.
Example. Bob makes a loan of £100,000 to his son John which he invests in a combination of shares and cash deposits. Over the following ten years these produce £30,000 of income and £20,000 in capital growth. This all belongs to John. Had it been in Bob’s name the £50,000 increase in value would have been part of his estate and so could have resulted in an IHT bill of £20,000 (£50,000 x 40%).
Pro advice. A loan can be a convenient way to use your exempt gifts allowance. All you need do is write off up to £3,000 of the loan each year. This counts as a gift because it reduces the amount of money you’ll get back.
You could make a loan instead of an outright gift to your intended beneficiaries. Any growth or income the loan produces is then outside your estate immediately. As an added bonus, writing off £3,000 per year will also take advantage of the exempt gifts allowance, further reducing the potential IHT.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.