By: JOHN WESTWOOD
Managing Director, Blacktower Financial Management Group
financial@portugalresident.com
John Westwood is the Managing Director of Blacktower Financial Management (International). Please telephone 289 355 685.
WITH HOUSE prices increasing at a faster rate than the UK inheritance tax (IHT) threshold, more and more people are finding themselves with an IHT problem. For this reason, estate planning is becoming an increasing priority.
The estate planning market was rocked in 2006 when Gordon Brown announced changes which radically altered the way in which trusts could be used in estate planning. As a result, advising in this market now requires high levels of technical competence.
Below I have detailed some basic estate planning strategies and also two straight forward planning methods entitled a Loan Trust and Discounted Gift and Income Plan (DGIP).
Inheritance tax
Many people feel that they don’t need to worry about IHT. Indeed, those with estates valued at less than the nil-rate band (300,000 pounds sterling in 2007/2008) or who leave their estate to a surviving spouse or a charity won’t have an IHT liability.
The Chancellor reinforces this view by telling us that only six per cent of estates actually pay IHT (Budget 2007 speech). But what many people don’t know is that the government collected approximately 3.6 billion pounds sterling from IHT in 2006/2007 and they’re expected to take around four billion pounds sterling in 2007/2008.
With house prices increasing at a faster rate than the IHT threshold, more and more people’s estates are facing an IHT bill. Research from Halifax reveals that nearly a third of detached properties in the UK are valued above the current nil-rate band of 300,000 pounds sterling, compared to just 16 per cent five years ago.
To account for the rise in property prices over the past ten years, the government would need to raise the nil-rate band to 460,000 pounds sterling. But the government has said that it’s only increasing to 350,000 pounds sterling for the tax year 2010/2011, so who knows what the average house price will be then?
Many people are happy that their house is going up in value, but as house prices continue to outpace the nil-rate band, ordinary families could lose a substantial slice of their wealth to the government by doing nothing.
Many people, unknowingly, are even in a situation where the government could get their hands on more of their estate than their own children. Take the Smith family for example.
Mrs Smith is a widow. She dies leaving three children (Jamie, Ellen and Chloe) and an estate valued at 850,000 pounds sterling. An IHT rate of 40 per cent applies to the value of her assets above her available nil-rate band (see table 1).
However, you can help reduce your potential IHT liability by using a simple estate planning strategy illustrated by the triangle (AS = alternative solutions):
Starting from the bottom and working up, you can take advantage of a number of tax exemptions and products to ensure that the maximum amount of wealth is passed to the next generation.
1) The basics
The following basic planning principles should be considered first as part of any IHT solution:
Deed of variation: If you have inherited assets within the last two years, a deed of variation can be used to remove them from your estate with immediate effect.
Nil-rate band planning using an up to date will: Married couples can leave a legacy, equivalent to the value of their individual nil-rate band in their will. A discretionary trust can be used to prevent the value of one spouse’s estate falling into the estate of the surviving spouse.
Maximising exemptions: You can reduce the value of your estate for IHT purposes by:
• Using your annual IHT exemption – it is possible to give away 3,000 pounds sterling a year;
• Making gifts on marriage (exempt gifts);
• Normal expenditure out of income – exempt gifts of any amount can be made as long as it is made from surplus income.
2) Access
Once the basics are in place many individuals will be faced with an IHT dilemma – they’ve got an estate worth more than the nil-rate band, but can’t make a gift of capital as they rely on the income arising from it. If you face this dilemma there are two possible solutions.
Loan Trust: This is a solution for those who want flexible access to capital. You lend funds (capital) to a trust created for family members. These loaned funds are then invested to provide more income or capital growth, but the settlor can access capital at any time. Any income or growth arising on the investment is immediately outside of the estate for IHT purpose.
Discounted Gift and Income Trust: This may be appropriate for those who don’t need capital, but do require a fixed income each year. Here you make a gift of funds to a trust created for family members but retain a right to income. Income is paid until you die or the fund has been exhausted, whichever happens first. The value of the gift made to the trust may also be discounted for IHT purposes depending upon your life expectancy and the amount of income you choose to receive.
3) Lifetime gifts
If an IHT liability still remains, you may want to take advantage of the favourable taxation of lifetime gifts. This involves making a gift without retaining access to it, in short giving money away.
This will be treated as either a potentially exempt transfer (PET) or a chargeable lifetime transfer (CLT). If the gift is not covered by the exemption, you will need to survive seven years for the value to fall outside your estate for IHT purposes.
4) AS – alternative solutions
If none of these solutions are suitable, or you are still left with an IHT liability, it may be necessary to consider alternatives.
You could take out a life insurance policy to fund for the anticipated IHT liability. Or you may want to consider investing in assets that qualify for IHT relief, such as business property relief and/or agricultural property relief. For example, assets such as shares in the Alternative Investment Market (AIM) stock would provide a tax-efficient investment albeit at a high risk.
