The Chancellor is expected to announce a number of changes to inheritance tax in the coming Budget and advisers will play a pivotal role in helping individuals make this legislation work for them
The run-up to the end of the tax year is traditionally the time when many advisers turn their thoughts to inheritance tax (IHT) issues and organising their clients' affairs accordingly.
This year, as in previous years, there is much speculation about changes that may arise as a result of proposed legislation in the Budget on 17 April ' prompting considerable tax planning activity on the part of advisers.
The fact is however that inheritance tax has now become an issue for so many clients that more and more advisers are making it a key consideration in financial planning throughout the year. There are a number of key trends in this field at the moment, which make inheritance tax a highly attractive area for intermediaries.
IHT was originally devised as a means of ensuring that wealthy individuals who inherited their wealth rather than earning it did not slip through the tax net. By levying a tax on inherited wealth and property, the government could collect tax from individuals who did not work for a living and were therefore not subject to income tax on their earnings.
This idea was logical enough in previous centuries ' but the irony of today's IHT situation is that most people with a level of wealth that makes them liable for IHT have actually earned that money over the course of their lifetime. As a result the wealth has already been subject to income tax or capital gains tax ' creating a potential double taxation situation.
Most experts agree that IHT in the UK is overdue for reform ' not least because this was one of New Labour's manifesto pledges when it was first elected in 1997.
While the nil rate band has increased each year in line with inflation, it has failed to take account of the dramatic rise in property prices ' particularly in the South-East of England. With the current IHT threshold level at £242,000, it is not difficult to see how an individual with a reasonably sized house can fall into the IHT zone by their property ownership alone, let alone any savings portfolio. Inheritance tax has now moved from its status as a tax on the very rich to being a middle-class tax.
While the Chancellor did not specifically refer to inheritance tax in his pre-Budget report, in media reports in recent weeks would suggest that some form of tax increases are on the cards to enable the Government to fulfil its pledges of increased spending on public services.
There are a number of areas in the existing inheritance tax system that may be vulnerable to reform. The most often discussed is the potentially exempt transfer rule (Pets). Abolishing Pets would close down a significant loophole in terms of inheritance tax avoidance ' and would also limit the scope of many existing retail trust and bond products that rely on this mechanism to mitigate inheritance tax.
Even if they are not abolished altogether, there is the possibility that this rule may be reformed, with perhaps the requisite survival period (currently seven years after the gift is made) being extended to 10 years. In view of this, it makes sense to ensure that clients use up their existing IHT relief in the meantime.
Another aspect of the system that may well be up for reform is the fact that the UK is currently something of a tax haven for individuals resident in the UK who may be domiciled elsewhere. This group includes professionals and business people from abroad currently working in the UK and has been the subject of media attention in recent weeks. Assets they own sited outside the UK do not currently fall into the IHT net.
The most likely change is that the rules governing trusts for these individuals will be changed. Alternatively a more radical reform of IHT could base this tax not on domicile, but on residence. In either case, swift action by advisers now could protect their non-domiciled clients.
Another area that may change is the nil rate band. Although the nil rate band threshold, currently £242,000, has been raised in line with inflation in the last few years, it has not taken account of rising property prices ' and so the number of people in the IHT net has risen.
A popular Budget prediction is for the Chancellor to raise the nil rate band to £500,000 and at the same time, tighten the existing loopholes to ensure that those who are still affected by IHT are less able to carry out legitimate avoidance. Even so, many clients with substantial property and a portfolio of investments will still be affected, and advisers have an important role to play in raising awareness and ensuring their clients ' particularly high net worth clients ' make the necessary provision for their future.
The message for advisers and their clients is that if inheritance tax is a concern, then action is better taken now under a known regime than deferred to a new and possibly less favourable regime in the future.
Of course, while there are more people than ever before being affected by inheritance tax, it is also true that IHT is often described as a voluntary tax. By taking steps during their lifetime, it is possible for individuals to mitigate the potential effect of inheritance tax on their wealth. Advisers have a vital role to play here and expertise in this area can provide the key to their future business growth.
One of the key roles for the intermediary in the field of IHT is that of educating and informing their clients that the tax is not simply the preserve of the very wealthy and that it may well be relevant to their situation. Many people are unaware that the current nil rate band of £242,000 includes their property as well as their investment portfolio. In addition, many people are surprised to learn that inheritance tax is charged at a flat rate of 40%.
One of the most interesting areas is that of tax-free investments such as Isas and Peps. While it is true that Isas are tax-free investments during the lifetime of the investor, on death they immediately become part of the estate for inheritance tax purposes. Many investors are not aware of this and so may have amassed a considerable portfolio of Isas and Peps in the belief that they will escape the IHT net. In fact, if an investor had used up their maximum Isa and Pep allowance, including single company Peps, since this type of investment was launched into the market, their portfolio would now be worth £229,295 ' assuming that their investments had grown at the same rate as the average unit trust. This means that they are practically over the threshold with that alone ' and it is likely therefore that some steps will have to be taken to mitigate their inheritance tax liability.
There are a number of talking points in the field of IHT that would serve advisers well as a catalyst for approaching their clients about the subject. What are the best solutions to recommend?
The first thing to stress is that each client's circumstances will be different ' and many of the issues that emerge during tax planning will depend very much on client wants and needs. Trusts for example, in conjunction with an onshore or offshore insurance bond, are an excellent means of tax planning. But the type of trust that is used will depend on whether the client wants to gift away capital entirely or retain access to their capital during their lifetime ' as can be achieved using some offshore bond and trust arrangements.
The important thing is that advice on inheritance tax planning cannot readily be obtained from other sources ' such as banks or online providers ' so advisers who are conversant with this area are in a position of strength. In the current climate of depolarisation, advisers will be considering which route to take in terms of development of their own business. Whichever option is taken, strong client relationships will continue to form the bedrock of a successful adviser business. Being able to offer the expertise of inheritance tax planning will help cement client relations going forward.
Advisers wishing to hone their skills will find a wealth of support from life offices, which generally offer a broad range of marketing and technical support in this area.
Whatever Chancellor Brown's Budget may bring in the shape of legislative change, advisers will have a pivotal role in helping individuals plan their inheritance tax situation in the future ' and this makes it an excellent means of future business growth.
IHT was originally designed as a means of ensuring wealthy individuals who inherited money rather than earning it did not slip through the tax net.
IHT reform was one of New Labour's manifesto pledges when elected in 1997.
Inheritance tax has now moved from a tax on the very rich to a middle-class tax.
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