By Nigel Smith, Technical Consultant, Friends Provident International The inheritance tax (IHT) r...
By Nigel Smith, Technical Consultant, Friends Provident International
The inheritance tax (IHT) regime introduced by the Finance Act 2006 is now upon us and this means solutions previously relied upon by tax advisers may no longer be appropriate. The changes mean that IHT planning has become more difficult.
Most insurance-based IHT plans were based on lifetime flexible trusts, which means, under the new rules, there could be a potential 20% IHT liability on the way in and a maximum 6% charge every 10 years when capital leaves the trust.
The simplest way to plan for IHT is to cover the liability with a term assurance or whole-of-life contract written in trust for the beneficiaries. Under the new rules, the premiums into the plans will continue, for the most part, to be exempt either because they fall within the annual £3,000 exemption or the client can claim the regular gifts out of income exemption.
If neither of these can be used, the amounts paid will be chargeable transfers. The good news is that only very large premiums are likely to exceed the nil-rate band. But any amounts that are not exempt will eat into the nil-rate band available for other planning.
In relation to the periodic and exit charges, there will generally be no problem because there will be no surrender value (in the case of term assurance) or the surrender value will not exceed the nil-rate band (in the case of whole of life). However, a charge to tax could arise if the insured is terminally ill and the policy pays out just before a 10th anniversary and remains in cash.
The most well-known schemes in the market are loan trusts, retained interest trusts and discounted gift trusts. All these plans aim to reduce exposure to IHT while providing access to capital and avoiding the gift with reservation rules.
Loan trusts allow unlimited amounts of capital to be gifted without creating an immediate entry charge because no gift actually occurs at outset. Growth is immediately outside the settlor's and beneficiaries' estates. The periodic and exit charges will be based on the value of the trust fund less any outstanding loan amounts.
In relation to discounted gift trusts, the discounted amount will be the relevant figure for the purposes of the entry charge. For those in good health, substantial amounts can be invested before an entry charge is levied.
It is important to note that when a beneficiary dies the trust fund will no longer form part of an estate for IHT.
There may be many individuals who make substantial gifts above the nil-rate band and wish to avoid all the tax charges of the 'relevant property' regime.Flexibility over beneficiaries is also not a major concern. They could use bare trust versions of the loan trust, retained interest trusts or discounted gift trusts.
The main advantages are:
lNo chargeable transfer.
lThere is no need to complete
lNo periodic/exit charges.
lDoes not affect taxation of
any flexible trusts created.
lChargeable events on benefi-
ciary if over 18.
The main disadvantage is that once you have chosen beneficiaries you are unable to change them. The plans have built-in mechanisms to prevent beneficiaries defeating the settlors' carved out rights while they are alive.
Despite the IHT arena be-coming more complicated, there are schemes that will work but clients will require good advice.
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