Our investments, spread over five building societies, total Pounds 150, 000, the interest from which we need to supplement our pensions. We own our home which is currently valued at Pounds 65,000.
We are in the vexed position of not knowing how much capital the surviving partner is likely to need, in the event of private nursing care being required.
I am sure there are many couples in a similar situation who read your column and would also benefit from advice.
A Inheritance tax (IHT) is often called a voluntary tax because there are so many exemptions.
However, these depend upon the donor alienating him or herself from all rights attached to the assets that are being passed on or gifted, creating the classic problem that you describe whereby you would like to avoid IHT but need your assets during your lifetime.
The principal exemptions are as follows: The first Pounds 150,000 of a gift is subject to IHT at a zero rate. This is referred to as the "nil rate band".
Every individual can gift up to Pounds 3,000 per year free of IHT and quite independent of the nil rate band. This is referred to as the "annual exemption".
Any lifetime gift to another individual will be exempt from IHT if the donor survives seven years after the date of the gift. Such gifts are called "potentially exempt transfers" or "PETs".
Gifts between spouses are always exempt. This is called the "spouse exemption".
There are a number of basic IHT planning exercises that can be adopted which make use of these exemptions.
It is sensible to split assets equally between spouses. This is referred to as "equalising the estates". There are tax reasons for doing this.
First, each individual has their own income and capital gains tax annual allowance. By splitting assets, and thus income and gains, equally between spouses, married couples ensure that they both make use of their annual allowances, thereby minimising their tax bill.
Second, equalising the estates ensures that each spouse has the opportunity to make use of the IHT nil rate band and annual exemptions.
The most common way of using the nil rate band is by ensuring that each spouse gifts up to Pounds 150,000 to their children under the terms of their wills. In your case, for example, if you split your investments equally, each of you could gift up to Pounds 75,000 to your children under your wills with the balance of your estates (the value of a half share in the house) to the surviving spouse. On the second death the total value of the survivor's estate would then fall within the nil rate band and no tax would have been paid on either death.
Annual exemptions can be used to make smaller gifts to your children during your lifetime as and when you feel you can afford to gift money out of your investment portfolio.
PETs can be used to make larger lifetime gifts, but remember that if you don't survive for seven years part of the value of the gift will be taken into account in assessing your IHT liability, if any, on death.
However, in your case, you do not feel able to equalise your estates so as to gift any investments on the first death because the survivor will need the income. Therefore, you need to consider gifting an interest in your house which requires much more sophisticated planning.
Unfortunately, you cannot gift the house outright to the children and carry on living there. The Revenue regard this as a "gift with reservation", which means you will not have successfully alienated yourselves from all the rights attaching to the asset gifted, and the house will be treated as remaining in your estates for IHT purposes.
There is a way round this problem. Under English law there are two kinds of interest in property, leasehold and freehold, which can be treated separately in law and for IHT purposes. It is, therefore, possible to split your interest in the house into a lease, granted to yourselves for a term of years roughly equivalent to the life expectancy of the spouse likely to live the longest, and the freehold, which you can gift outright to your children. Because your only interest in the property is now the lease, the gift of the freehold, in which you no longer have any interest, is not caught by the gift with reservation rule.
The value of the freehold interest at the date of the gift is only nominal, because the leasehold interest is the more valuable of the two at outset, but over the term of the lease the leasehold interest decreases in value and, correspondingly, the freehold interest rises in value.
Consequently, at the date of the death of the surviving spouse the lease should be all but exhausted, having only a nominal value, and the freehold interest should have a value close to the open market value of the property had no lease been granted. Thus, you will have successfully passed a valuable asset out of your estate to your children during your lifetime but without affecting your standard of living.
This is obviously a complex piece of IHT planning and should only be entered into on the advice of your solicitor and in conjunction with sensible planning of your wills.
Andrew Warwick-Thompson is a lawyer who works for Bacon and Woodrow, the international firm of actuaries and consultants. Readers who wish to put questions to him (no names will be published) should write to: Personal Finance Desk, The TES, Admiral House, 66-68 East Smithfield, London E1 9xy (fax: 071 782 3200). No personal correspondence will be entered into and no legal liability will be accepted for the advice offered.