The last two years have shown a meteoric rise in the value of property. In a debt driven economy, such a rise creates ‘benefits’ to the economy through the perception of being more wealthy. If we feel we have more liquidity and space between the value of our home and debt, we’ll spend more. Simple.
Our worst-case scenario is that we can simply sell when we need to in order to clear the debt.
Over the past 33 years in financial services, I have experienced many ‘releasing equity’ from their home to go buy cars, boats etc. In reality, they are not releasing equity, they are borrowing more money, and this is potentially a pretty efficient way to do it given the interest rate.
Of perhaps greater concern, however, is the impact on Inheritance Tax (IHT) on the recipients of the home when it is passed over after death.
Inheritance tax nil rate band
Currently there is an amount (a ‘nil rate band’ is the technical term) you can give away on death without having to pay Inheritance Tax. 40% is payable on estates over £325,000, but, if your estate is not valued above £2m, you have a further £175,000 residence nil rate band you can use, meaning £500,000 for the husband and £500,000 for the wife.
Where previously there was no issue for Inheritance Tax on the remaining part of a person’s estate, this surge in house prices has pushed some into the Inheritance Tax net on money they believed to be safe.
Consequently, many look at gifting assets away before they die where they think these assets might move above this and also where they simply want to see the difference their gifts make to their family living a more comfortable life.
Here are some simple options to make gifts to your family whilst you are alive.
The easiest one is the gift out of normal expenditure. With this option, the gift must come from your income, and you must be left with enough income to maintain your standard of living. It cannot be a gift from capital and must also form a pattern of habitual gifting.
There is no defined period for this, but a period of three to four years is normally considered to be suitable.
Gifts and inheritance tax
There is also the annual gift exemption of £3,000 which can be carried forward just one year, so a couple who missed last year could give £12,000 in the second year.
If you are educating children or making payments for maintenance for them these payments are not subject to IHT.
In the case of a marriage, each parent can give £5,000 and each grandparent can give £2,500.
For those feeling charitable, gifts to charities and political parties (!) as well as gifts for national benefit such as the national trust museums, universities or libraries are all exempt gifts for Inheritance tax.
Those not wishing to make any plans now (gift anything away) and wishing to be totally flexible in their planning often decide to just insure against the tax. For example, if the taxable estate is £400,000 over the nil rate bands mentioned above, the tax payable would be £160,000 (40%). The person whose estate is taxable simply insures themselves for £160,000 and places that death benefit into trust for the beneficiaries.
This is a straightforward trust document that ensures the money does not come into the estate and goes directly to the beneficiaries who now pay the tax, and release the estate for their ownership. One might argue that paying these premiums is paying the tax in advance, but it is quite easy to ask your Independent Financial adviser to quote for the premium to see if it is affordable.
For those of you who have life insurance policies already, decide if you wish to place the death benefits into trust now otherwise, they will come into your estate, be taxed, and then paid out according to your will.
Another option is gifting the property to the children. That is a bigger subject for next week. If you have question about Inheritance tax, you can call 01872 222422, email [email protected] or visit wwfp.net.
For more content about IHT and estate planning see our finance channel.
About the Author / Peter McGahan
Peter McGahan is Chief Executive Officer of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
