Avoiding Inheritance Tax

As is outlined in another article in this section, inheritance tax, or IHT, is a growing concern in the UK. As house prices rise, the number of individuals affected by IHT grows. As such, ensuring that you can utilise the law to maximise the tax efficiency of your estate has never been so important.

In the first instance, it is important to note that 'tax avoidance' is perfectly legal; you are well within your rights to attempt to minimise your tax liabilities through legal means. Trusts are a potentially effective method of legally reducing an inheritance tax bill, not for the owner of the estate but for their dependants after the owner's death. This is most commonly achieved through the use of what is known as a Nil Rate Band Discretionary Trust.

Nil Rate Band

Everybody is entitled to an IHT exemption on the first part of their estate. The exempt portion is known as the Nil Rate Band, the upper limit of which changes annually along with inflation; it is currently set at £325,000. The key to successful inheritance tax planning is to ensure that this Nil Rate Band is used efficiently. This is particularly the case if you have a spouse; all too often, individuals write simple wills that pass their entire estate straight on to their spouse, and therefore making use of only one of their two available exemptions.

Nil Rate Band Discretionary Trusts ensure that the exemptions granted by law are utilised to their full extent. They are actually very simple. When an individual establishes this type of trust, they transfer assets to the value of the current Nil Rate Band into a trust. In this way, they have divorced themselves from those assets; they are no longer counted as part of the individual's estate, and are therefore no longer subject to Inheritance Tax. Ideally, the remainder of the individual's estate will fall below the Nil Rate Band, meaning that this too will be exempt. In this way, on the death of the first settlor there should be no inheritance tax liability.

Income

After their death, the spouse or other dependant can draw an income from the assets held in trust, thus helping to ensure some financial security. This is particularly important if the deceased individual was the main earner. They are also entitled to take out loans, interest-free, from the assets remaining in trust. These will be paid back from the spouse's own estate, thus further lowering their own IHT liability. Indeed, the spouse can also establish their own trust, which will offer their children, or other beneficiaries, the same advantages that they enjoyed.

There are, however, a number of potential disadvantages associated with this type of trust. Primarily, it must be remembered that assets transferred into trust are subject to IHT immediately on transfer if they exceed the Nil Rate Band; this is why assets are generally only transferred up to this value. The potential problems of these trusts are explored in more detail in another article in this section; a solicitor or other legal professional will be able to give you advice regarding your own individual situation.