Sheltering investments from tax

Even though the end of this tax year may seem fairly distant, if you haven’t yet taken full advantage of your Individual Savings Account (ISA) allowance you could be missing out from sheltering your investments from tax.

ISAs enable you to hold investments and pay no capital gains tax and no further tax on the income you receive. From 6 April 2010, the government increased the ISA allowance limit to £10,200 for all eligible ISA customers.

An ISA is a tax-efficient ‘wrapper’ in which you can hold either stock market-based investments or a traditional savings account. Any interest earned on savings or bonds and any capital gains made on investments within an ISA are tax-free.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.

Planning ahead is the key

An increasing number of people are becoming liable to inheritance tax (IHT) because of the increase in property prices from the early 1980s to 2007. IHT applies to your entire worldwide estate (including property) and is charged at 40 per cent. But you also need to add in the value of savings, investments and chattels (such as antiques, jewellery and paintings) to estimate the entire value of your estate.

Planning ahead for when you die allows you to set out clearly who should get what from your estate. It also means you can maximise IHT reliefs and exemptions if your estate might be worth more than the IHT threshold when you die (£325,000 in 2010/11).

Making a will and being sure people know where to find it is the first step to ensuring that your estate is shared out exactly as you want it to be when you die.

If you don’t leave a will, your estate will be shared out among your next of kin according to a strict order of priority called the ‘rules of intestacy’. This means that people you want to benefit from your estate, such as a partner you’re not married to or in a registered civil partnership with, might get nothing. The rules are different in Scotland.

Gifts are treated in a number of ways for IHT purposes. However, you only need to worry about making gifts if you think your estate, including the value of any gifts you make, might exceed the IHT threshold when you die. If your estate is over the threshold, any gifts you make more than seven years before you die will be exempt from IHT.

There can be tax implications if you give your home away to your children or someone else, especially while you’re still alive. If you give your home away and continue to live in it, your estate or the person you gave your home to might still have to pay IHT on the property when you die, as well as other taxes.

You can also use a trust to pass assets on to others, for example to those who aren’t immediately able to look after their own affairs, such as your children. Gifts into a trust may still be subject to IHT if your estate, including the amount being transferred, is over the IHT £325,000 threshold.

our questions answered

Q: Why is the government planning to end the default fixed retirement age?
A: Many people are not saving enough for retirement and risk not having the income they would hope for if they retire at the ‘traditional’ age of 65.

By working for one year past the existing state retirement age, currently 60 for women and 65 for men, people could potentially increase their retirement income by between 3 per cent and 10 per cent. The government says it wants to tackle age discrimination, but this move will also alleviate the burden on the state.

Q: Am I able to work beyond 65 now if I want to?
A: This will ultimately depend on your own employer. Employers do not have to retire employees once they reach 65, and are free to continue to employ them as long as they wish, but some may require you leave at 65.

Q: Will I still be able to retire at 65 under the new proposals?
A: Yes. The government has not indicated that it will prevent people from retiring at 65.

Q: Will I be able to retire even earlier?
A: Some people with private pensions are already able to retire from the age of 55. Individual employers may allow you to retire early.

Q: Will I be able to contribute to my company pension beyond 65?
A: Yes, you will be able to keep contributing to your pension. You can continue to make pension contributions and receive tax relief up to your 75th birthday.

Q: If I work longer, can I save less for retirement?
A: No. The government wants workers to contribute more to their pension provisions, not less. The larger your pension, the less of a burden as a retiree you might be on the state.

Q: Does the change affect my state pension entitlement?
A: The state pension has its own timetable, which is also currently under review. The government is consulting on how it can accelerate the planned rises to the state pension age more quickly than is currently legislated for, initially to age 66 but ultimately to 68.

The government has yet to announce whether those working longer will be able to defer their state pension. If you take it at age 66 but work until you’re 70, you would pay tax on your state pension as if you are still working, so there are plenty of details to be ironed out by the government.

Making the most of different solutions

Decreasing term assurance
Decreasing term assurance can be arranged to cover a potential Inheritance Tax liability and used as a Gift Inter Vivos policy (a gift given during the life of the grantor who no longer has any rights to the property and can not get it back without the permission of the party it was gifted to). This is a type of decreasing term plan that actually reduces at the same rate as the chargeable Inheritance Tax on an estate as a result of a Potentially Exempt Transfer (PET).

For example, if you gift part of your estate away before death, then that part is classed as a PET, meaning that for a period of seven years there could be tax due on the transfer. This amount of tax reduces by a set amount each year for seven years.

The Gift Inter Vivos plan is designed to follow that reduction to ensure sufficient money is available to meet the bill if the person who gifted the estate dies before the end of the seven-year period.

Such policies should be written in an appropriate trust, so that the proceeds fall outside your estate.

Business and agricultural property
Business and agricultural property are exempt from Inheritance Tax.

Business Property relief: To qualify, the property must be ‘relevant business property’ and must have been owned by the transferor for the period of two years immediately preceding death. Where death occurred after 10 March 1992, relief is given by reducing the value of the asset by 100 per cent. Prior to 10 March 1992, the relief was 50 per cent.

Agricultural Property relief: Agricultural property is defined as ‘agricultural land or pasture and includes woodland and any buildings used in connection with the intensive rearing of livestock or fish if the woodland or building is occupied with agricultural land or pasture and the occupation is ancillary to that of the agricultural land or pasture; and also includes such cottages, farm buildings and farmhouses, together with the land occupied with them as are of a character appropriate to the property’. Where death occurred after 10 March 1992, relief is given by reducing the value of the property by 100 per cent (certain conditions apply). Prior to that date the relief was 50 per cent.

Woodlands relief
There is a specific relief for transfers of woodland on death. However, this has become less important since the introduction of 100 per cent relief for businesses that qualify as relevant business property.

Where an estate includes woodlands forming part of a business, business relief may be available if the ordinary conditions for that relief are satisfied.

When a woodland in the United Kingdom is transferred on death, the person who would be liable for the tax can elect to have the value of the timber – that is, the trees and underwood (but not the underlying land) – excluded from the deceased’s estate.

If the timber is later disposed of, its value at the time will be subject to Inheritance Tax. Relief is available if:

– an election is made within two years of the death, though the Board of HM Revenue & Customs have discretion to accept late elections, and

– the deceased was the beneficial owner of the woodlands for at least five years immediately before death or became beneficially entitled to it by gift or inheritance

The Pre-Owned Assets Tax
Pre-Owned Assets Tax (POAT), which came into effect on 6 April 2005, clamped down on arrangements whereby parents gifted property to children or other family members while continuing to live in the property without paying a full market rent.

POAT is charged at up to 40 per cent on the benefit to an individual continuing to live in a property that they have gifted but are not paying a full rent, and where the arrangement is not caught by the Gift with Reservation rules.

So anyone who has implemented such a scheme since March 1986 could fall within the POAT net and be liable to an income tax charge of up to 40 per cent of the annual market rental value of the property.

Alternatively, you can elect by 31 January following the end of the tax year in which the benefit first arises that the property remains in your estate.

Rental valuations of the property must be carried out every five years by an independent valuer.

Using a trust to pass assets to beneficiaries
Trusts may incur an Inheritance Tax charge when assets are transferred into or out of them or when they reach a ten-year anniversary. The person who puts assets into a trust is known as a ‘settlor’. A transfer of assets into a trust can include property, land or cash in the form of:

– a gift made during a person’s lifetime
– a transfer or transaction that reduces the value of the settlor’s estate (for example an asset is sold to trustees at less than its market value) – the loss to the person’s estate is considered a gift or transfer
– a ‘potentially exempt transfer’ whereby no further Inheritance Tax is due if the person making the transfer survives at least seven years. For transfers after 22 March 2006 this will only apply when the trust is a disabled trust
– a ‘gift with reservation’ where the transferee still benefits from the gift

If you die within seven years of making a transfer into a trust extra Inheritance Tax will be due at the full amount of 40 per cent (rather than the reduced amount of 20 per cent for lifetime transfers).

In this case your personal representative, who manages your estate when you die, will have to pay a further 20 per cent out of your estate on the value of the original transfer. If no Inheritance Tax was due when you made the transfer, the value of the transfer is added to your estate when working out whether any Inheritance Tax is due.

Settled property
The act of putting an asset into a trust is often known as ‘making a settlement’ or ‘settling property’. For Inheritance Tax purposes, each item of settled property has its own separate identity.

This means, for example, that one item of settled property within a trust may be for the trustees to use at their discretion and therefore treated like a discretionary trust. Another item within the same trust may be set aside for a disabled person and treated like a trust for a disabled person. In this case, there will be different Inheritance Tax rules for each item of settled property.

Even though different items of settled property may receive different tax treatment, it is always the total value of all the settled property in a trust that is used to work out whether a trust exceeds the Inheritance Tax threshold and whether Inheritance Tax is due.

If you make a gift to any type of trust but continue to benefit from the gift you will pay 20 per cent on the transfer and the gift will still count as part of your estate. These are known as gifts ‘with reservation of benefit’.

Avoiding double taxation
To avoid double taxation, only the higher of these charges is applied and you won’t ever pay more than
40 per cent Inheritance Tax. However, if the person who retains the benefit gives this up more than seven years before dying, the gift is treated as a potentially exempt transfer and there is no further liability if the transferor survives for a further seven years.

From a trusts perspective, there are four main occasions when Inheritance Tax may apply to trusts:

– when assets are transferred – or settled – into a trust
– when a trust reaches a ten-year anniversary
– when settled property is transferred out of a trust or the trust comes to an end
– when someone dies and a trust is involved when sorting out their estate

Relevant property
You have to pay Inheritance Tax on ‘relevant property’. Relevant property covers all settled property in most kinds of trust and includes money, shares, houses, land or any other assets. Most property held in trusts counts as relevant property. But property in the following types of trust doesn’t count as ‘relevant property’:

– interest in possession trusts with assets that were put in before 22 March 2006
– an immediate post-death interest trust
– a transitional serial interest trust
– a disabled person’s interest trust
– a trust for a bereaved minor
– an age 18 to 25 trust

Excluded property
Inheritance Tax is not paid on ‘excluded property’ (although the value of the excluded property may be brought in to calculate the rate of tax on certain exit charges and ten-year anniversary charges). Types of excluded property can include:

– property situated outside the UK that is owned by trustees and was settled by someone who was permanently living outside the UK at the time of making the settlement

– government securities, known as FOTRA (free of tax to residents abroad)

Declaring and paying Inheritance Tax
There are two main forms you will need to use to declare and pay Inheritance Tax for your trust:

– IHT400 Inheritance Tax Account – used to show what Inheritance Tax is due when someone has died

– IHT100 Inheritance Tax Account – used to show what Inheritance Tax is due from ‘lifetime events’, for example a transfer into or out of a trust, or a ten-year charge on a trust

Inheritance Tax is charged up to a maximum of 6 per cent on assets or ‘property’ that is transferred out of a trust. The exit charge, which is sometimes called the ‘proportionate charge’, applies to all transfers of ‘relevant property’.

A transfer out of trust can occur when:

– the trust comes to an end

– some of the assets within the trust are distributed to beneficiaries

– a beneficiary becomes absolutely entitled to enjoy an asset

– an asset becomes part of a ‘special trust’ (for example a charitable trust or trust for a disabled person) and therefore ceases to be ‘relevant property’

– the trustees enter into a non-commercial transaction that reduces the value of the trust fund

There are some occasions when there is no Inheritance Tax exit charge. These apply even where the trust is a ‘relevant property’ trust, for instance, it isn’t charged:

– on payments by trustees of costs or expenses incurred on assets held as relevant property

– on some payments of capital to the beneficiary where Income Tax will be due

– when the asset is transferred out of the trust within three months of setting up a trust, or within three months following a ten-year anniversary

– when the assets are ‘excluded property’ foreign assets have this status if the settlor was domiciled abroad

Passing assets to beneficiaries
You may decide to use a trust to pass assets to beneficiaries, particularly those who aren’t immediately able to look after their own affairs. If you do use a trust to give something away, this removes it from your estate provided you don’t use it or get any benefit from it. But bear in mind that gifts into trust may be liable to Inheritance Tax.

Trusts offer a means of holding and managing money or property for people who may not be ready or able to manage it for themselves. Used in conjunction with a will, they can also help ensure that your assets are passed on in accordance with your wishes after you die.

Writing a will
When writing a will, there are several kinds of trust that can be used to help minimise an Inheritance Tax liability. From an Inheritance Tax perspective, an ‘interest in possession’ trust is one where a beneficiary has the right to use the property within the trust or receive any income from it. Assets put into an interest in possession trust before 22 March 2006 are not considered to be relevant property, so there is no ten-yearly charge.

During the life of the trust there are no exit charges as long as the asset stays in the trust and remains the ‘interest’ of the beneficiary.

If the trust also contains assets put in on or after 22 March 2006, these assets are treated as relevant property and are potentially liable to the ten-yearly charges.

Trusts are very complicated, and you may have to pay Inheritance Tax and/or Capital Gains Tax when putting property into the trust. If you want to create a trust you should seek professional advice.

Handling the estate of someone who’s died
Probate (or confirmation in Scotland) is the system you go through if you’re handling the estate of someone who’s died. It gives you the legal right to distribute the estate according to the deceased’s wishes. Inheritance Tax forms are part of the process even if the estate doesn’t owe Inheritance Tax.

If the deceased left a will, it usually names one or more ‘executors’ or ‘personal representatives’, who apply for the grant of probate (also called a ‘grant of representation’).

Grant of letters of administration
If the deceased died without leaving a will, a blood relative can apply for a ‘grant of letters of administration’, depending on a strict next-of-kin order of priority defined in the ‘rules of intestacy’. This makes them the ‘administrator’.

If the named executor does not want to act, someone else named in the will can apply to be the administrator (again, depending on a strict order of priority). The catch-all term for an executor or administrator is ‘personal representative’.

Scotland and Northern Ireland have different legal systems, processes and terms. The terminology is generally the same in Northern Ireland. However, in Scotland the process is called ‘confirmation’ and the personal representative applies for a ‘grant of confirmation’. Different forms are required in Scotland and Northern Ireland too.

The probate process
An overview of the steps to take in England and Wales:

– value the estate and speak to the deceased’s banks and other financial organisations to establish whether you need probate (or confirmation)

– if you do need probate, complete the relevant probate application and Inheritance Tax forms, these differ depending on whether or not the estate owes Inheritance Tax

– send the forms to the relevant government bodies (in England and Wales, that’s the Controlling Probate Registry and HM Revenue & Customs)

– pay whatever Inheritance Tax is due

– attend an interview at the Probate registry and swear an oath

– wait for the grant of probate (or confirmation) to arrive in the post, banks and other organisations will ask to see this before they allow access to the deceased’s assets

– pay any debts owed by the estate and then distribute the estate

When you might not need probate
Probate may not be needed if the estate:

– when you as the executor or personal is a low-value estate – generally worth less than £5,000 (though this figure can vary) and doesn’t include land, property or shares
– passes to the surviving spouse/civil partner because it was held in joint names

When you as the executor or personal representative contact the deceased’s bank or other financial institutions, they will either release the funds or tell you to get a grant of probate (or confirmation) first. Some banks and financial institutions may insist on a grant before giving you access to even a small amount of money.

When probate is usually needed
You will almost certainly need probate if the estate includes:

– assets generally worth more than £5,000 in total (though again this figure varies)
– land or property in the name of the deceased, or held as ‘tenants in common’ with someone else
– stocks or shares
– some insurance policies

If you’re going through the probate process, you’ll have to fill in an Inheritance Tax form in addition to the PA1 Probate Application form, even if the estate doesn’t owe Inheritance Tax. The estate will only owe Inheritance Tax if it’s over the £325,000 nil rate band (2010/11).

Inheritance Tax forms
The Inheritance Tax forms you need depend on where the deceased lived, England, Wales, Scotland, Northern Ireland, or abroad, the size of the estate and whether it is an ‘excepted estate’.

Usually, if an estate has no Inheritance Tax to pay, it will be an excepted estate. However, this is not always the case. Some estates that don’t owe Inheritance Tax still have to return a full Inheritance Tax account.

If you’re not sure whether the deceased’s estate is an excepted estate, you’ll need to start by filling in a Return of Estate Information form to find out (form IHT205 in England and Wales). Depending on your answers to certain questions, the form will make clear when you should stop filling out that form and switch to form IHT400 (a full Inheritance Tax account) instead.

Probate Application
If you have filled in form IHT205, send that and form PA1 Probate Application to your nearest Controlling Probate Registry along with the original will, the death certificate, and the probate fee. The process is different in Scotland and Northern Ireland.

If the estate owes Inheritance Tax, you won’t get the grant of probate (or confirmation) unless you pay some or all of the Inheritance Tax first. The ‘due date’ is six months after the date of death.

Once you’ve paid any Inheritance Tax and sent off the forms to the Controlling Probate Registry, the process takes about six weeks if there are no problems. These are the stages:

– examination of forms and documents – Probate Registry staff check the forms and documents and prepare the probate papers

– probate interview – all the executors who have applied attend an interview to review the forms and swear an oath, either at the Controlling Probate Registry or interview venue

– probate is granted – the grant of probate is sent to
you by post from a district Probate Registry

After you receive the grant of probate (or confirmation) and have paid any Inheritance Tax due, you can collect in the money from the estate, pay any debts owed by the estate and then distribute the estate according to the will or the rules of intestacy.