Uncategorised

Death and Taxes

By Andy Hearne 4th August 2016

This article was originally published on Quadrant Group’s website. Quadrant Group was acquired by Progeny in March 2017.

“In this world, nothing can be said to be certain, except death and taxes.”
— Benjamin Franklin

Inheritance Tax forms with a Last Will & TestamentIt’s a cheery thought, but never have truer words been spoken, and Inheritance Tax sums this up perfectly.

When we meet with our clients to review their affairs, we always strive to help them to take a step back and consider their overall position. This often includes looking at something called a Statement of Net Worth, which simply details a client’s Assets, Liabilities and Net Worth (i.e. the value of their overall estate if they were to pass away today and all debts had to be repaid).

This starting point enables us to calculate their current inheritance tax liability, if any, and begin exploring how best to mitigate this liability.

What is Inheritance Tax (IHT)?

Succession Duty (now known as Inheritance Tax) was first introduced in English Law in 1853. The aim was to help address the rich-poor divide by spreading wealth amongst future generations. Today, inheritance tax affects 1 in 3 UK homeowners.

The basic rules of inheritance tax are relatively simple. Each individual is entitled to the Nil-Rate Band (NRB), which is currently £325,000. This means that there is no inheritance tax payable on estates valued up to £325,000. Anything above the NRB is subject to inheritance tax at the rate of 40%, subject to certain exemptions, such as charitable donations. Transfers between spouses and civil partners are free of inheritance tax, but NRBs can also be combined, so couples are entitled to a combined NRB of £650,000.

From April 2017, the Government will also be phasing-in the new Additional Nil-Rate Band (ANRB), also known as the Main Residence Nil-Rate Band or the Family Home Allowance. The ANRB is based on the value of the family home and will be added to the NRB, rising from £100,000 to £175,000 per person by April 2020. In other words, each individual could be entitled to a total NRB of £500,000 or a combined £1m for spouses and civil partners.

However, it should be noted that, if the net value of the estate is above £2m, the ANRB would be tapered down by £1 for every £2 that the net value exceeds that amount. This means that, if a couple’s estate is above £2.7m, there would be no ANRB available whatsoever.

All this leaves many of our clients with a significant inheritance tax liability. However, we have a few tools in our bag to help our clients with Inheritance Tax planning:

  • Gifts and charitable donations
  • Trusts
  • Business Relief schemes (formerly Business Property Relief)
  • Life Assurance

Gifts and charitable donations

You would think that simply giving money away would be an easy way to reduce your IHT liability. Unfortunately, gifts are embroiled with legislation and certain rules, which means that planning the amounts, methods and timing of gifts is very important indeed.

Gifts are embroiled with legislation and certain rules, which means that planning the amounts, methods and timing of gifts is very important indeed.

For example, each individual is entitled to gift £3,000 per year within their lifetime, which immediately falls outside their estate for IHT purposes. This is known as the Annual Exemption. In addition, there are a number of other exemptions, such as gifts up to £5,000 for each child’s wedding and also gifts out of ‘normal expenditure’ (i.e. your disposable income). Charitable donations would also fall outside your estate for IHT purposes.

Gifts that are in excess of these exemptions may be classed as Potentially Exempt Transfers (PETs), which are subject to the 7-year Rule. This simply means that, so long as you survive for 7 years after making the gift, it would fall outside your estate for IHT purposes. However, if you don’t survive 7 years, some (or all) of that gift would be liable to IHT.

Here at Quadrant, we often help clients to assess their affordability and consider gifting with warm hands, rather than with a cold heart! We also look to utilise a suitable combination of the following IHT planning options:

1) Trusts

There are a variety of Trusts that can be used to help with Inheritance Tax planning. Here we will look at a couple of these.

Loan Trusts

One of the problems with Inheritance Tax is that the amount of the liability increases over time as the value of your assets grows. Loan Trusts offer a possible solution to this because any growth on the amount invested in a Loan Trust would fall outside your estate for IHT purposes. This means that even if there is an IHT liability on the money originally invested, it doesn’t continue to get any worse as the investment grows. What’s more, you also retain access to your original capital, if required, so it’s quite flexible and doesn’t compromise your financial security.

One of the problems with Inheritance Tax is that the amount of the liability increases over time as the value of your assets grows.

Loan Trusts work by segregating the value of the Loan (i.e. the amount invested) from the value of the Gift (i.e. any growth on the value of the amount invested). Since your original investment is merely a Loan, you are able to make withdrawals from this amount over time. These withdrawals are referred to as Loan Repayments.

Discounted Gift Trusts

Discounted Gift Trusts offer the potential of an immediate IHT reduction on a proportion of your investment from Day 1. To qualify for this immediate ‘discount’, the investment would require underwriting. The remaining balance remains in your estate for 7 years, after which time the whole investment is free of IHT. Unlike a Loan Trust, other than the specified fixed income at the outset, you do not retain access to your capital once invested. However, during your lifetime, modest amounts of capital withdrawals can be passed to the beneficiaries.

Discounted Gift Trusts work by placing an investment bond into Trust and the amount and frequency of regular withdrawals is fixed at the outset. On death, the beneficiaries can choose to continue the Trust or wind it up and either assign the bond or cash it in. Quadrant Group advisers usually advise on the most efficient way.

One other benefit of both Loan Trusts and Discounted Gift Trusts is that you have flexible investment options and you could choose to invest the proceeds in one of our AstutePortfolios.

2) Business Relief schemes (formerly Business Property Relief)

Business Relief schemes can be utilised to eliminate IHT that would otherwise be due on an amount invested in the scheme. The main benefit of this method is that all the money invested in a Business Relief scheme is currently free of IHT after 2 years. However, there are some important considerations. Such schemes tend to be more expensive and riskier than other investment strategies, but these downsides may be outweighed by the benefits of the potential IHT saving and 2-year timeframe.

Business Relief schemes work by utilising legislation surrounding Business Assets and the risks to the business of the death of a Business Owner.

Business Relief schemes work by utilising legislation surrounding Business Assets and the risks to the business of the death of a Business Owner. There were formerly concerns surrounding the risks that businesses would need to be sold or broken up in order to pay an Inheritance Tax Bill upon the death of a Business Owner. These impact  Employment figures, Corporation Tax, Income Tax, VAT and National Insurance revenues, so the Government recognised that seeking Inheritance Tax from Businesses was, overall, somewhat counter-productive.

As a result, Businesses are subject to certain exemptions and Business Relief schemes seek to utilise these exemptions for Inheritance Tax planning purposes. There are various types of Business Relief schemes; some that are asset-backed (investing in tangible assets) and others that invest in AIM-listed shares. There are pros and cons with each type and there are important considerations with the investment risks and costs.

Andrew Pereira goes into further detail about Business Relief schemes here and highlights how these schemes are most suitable once other allowances have been utilised.

3) Life Assurance

Finally, there is always the option of taking out a Whole of Life Assurance on a Joint-Life Second-Death Basis. The aim of this would simply be to pay a tax-free lump sum upon death that would cover the remaining Inheritance Tax liability.

This would be set up in Trust at the outset, so the benefit is paid out immediately and outside the Estate for tax purposes. You should use Whole of Life and also Guaranteed Whole of Life plans, rather than Term Assurance as we do not know when we will die. These ensure that the sum assured would be payable whenever death occurs. However, Term Assurance could be utilised to cover an IHT liability for a gift that would otherwise fail the 7-year rule.

Unlike the other methods detailed above, life assurance doesn’t actually reduce the IHT liability, but simply ensures that funds are instantly available upon death for your beneficiaries to pay the IHT bill. One way to look at it would be that, in addition to your Gift allowances and PETs (subject to the 7-year rule), the monthly cost of the Life Assurance is just another way of pre-funding a Trust, therefore another way of tax-efficiently gifting money to your beneficiaries.

Summary

As you can see, the options available are numerous, and each method has a number of important considerations. It’s the old adage, tax can be taxing, so always seek professional financial advice from someone you can trust. I intend to write more articles in the coming months about how different schemes work and what to look out for, so watch this space.

Free Download  The Complete Guide to Inheritance Tax  How to keep your wealth in the family Download Now

This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and the value of investments can fall as well as rise. No representation is made that the stated results will be replicated.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.