The pre-Budget report brought about changes to IHT but what does this mean for IFAs? Peter McGahan examines the Government's reasons for the changes and the implications for advisers
The last few pre-Budget reports have been dominated by issues in relation to inheritance tax (IHT). I wonder why. It's very interesting to see what the potential may be for the future of IHT planning for the IFA.
Before going into them it's worth taking a closer look at what motivation the Government has for this latest bout of changes.
The decision to change legislation to include a simple usage of the two nil-rate bands was an interesting one. On the face of it, there was little change - or was there? More on that in a second.
Why, I asked myself, has the Government proposed this change? I approached the answer with the assumption that the Government didn't want to take in less tax.
We all know there are plenty of people who do not use the first nil-rate band on death and that money is easy picking for the Government on second death. Why give that away?
Is it possible this will offer the ability for it to get rid of the need for a deed of variation, and hence, when it deletes that option, there will be less of an outcry?
This will then open the potential for future tweaks to the system that cannot be closed off after the event, and forces people to make stronger and less flexible decisions now.
Perhaps the real reason may relate to the gain it takes on IHT versus care costs. Consider that only 40% of the excess over £300,000 is taxed for IHT. For long-term care the tax is potentially almost 100% of the estate.
Currently the first nil-rate band planning on death allows for plenty of complications for local authorities. How do you value a property on the open market when it is partly owned with a tenancy in common? It is valueless. What happens when the other tenancy is owned by a trust? Other assets can also be owned as tenants in common. Pre-first death planning may involve taking certain cash elements outside of the estate, which further complicates matters for local authorities in determining estate values.
The change to allow individuals to use both nil-rate bands on second death could easily lure people into thinking there is no point in planning for IHT on first death. The above may well be the mackerel to catch the bass, I wonder.
In relation to any care remember, however, the rule on deliberate deprivation of capital. Any planning should be completed well in advance of any thoughts of going to care.
In many ways it will be business as usual. For us these changes do little to deflect us from what we are already doing. So what were the options and how have they changed?
This introduction should now negate the need for life insurance policies written on a second death basis for those with estates of £600,000 or less, and nail the coffin lid for this type of planning, that, for me, never had a place to play. While nothing here has changed, some advisers had continued to plan for estates over £300,000 using life insurance plans. This was, and still is, a waste of time and money and doesn't mitigate the tax; it just ensures the Government receives it. Above £600,000 things become interesting, however.
Clearly trust work is one of the best ways to plan over and above this number if you want to mitigate the tax. This of course has not changed in the pre-Budget, so all is well again.
As well as the above care planning, one real area is open for loss. That's the use of three nil-rate bands.
Under a discretionary trust created on first death, the surviving spouse would be a trustee who could also benefit under its terms. In other words the deceased has left an amount to a discretionary trust that the spouse can continue to have access to, although not exclusively.
The discretionary trust could also be set up with the power for the surviving spouse to have access to loans on an interest-free basis.
The trustees could make interest-free loans repayable on demand to the surviving spouse and he/she could spend the money as income. This would mean that on the surviving spouse's death, the outstanding loan would be regarded as forming a debt on their taxable estate and therefore further reduce the IHT liability at that time. This is a way of using three nil-rate bands and ensuring estates of £900,000 do not pay any IHT.
While this has not changed, the individual with any apathy toward planning because of today's changes would miss out. The initial trust would have to be instructed to have been set up on the first death. If it isn't this form of planning will be lost - an immediate £120,000 tax charge.
Those customers with estates of £500,000 upwards may find themselves in a little bit of a no-man's land. Will their estate increase sufficiently pre-death that they need to provide for trust planning now? If so, they will need to plan immediately.
Remember the current changes are such that they don't encourage you to use a gift today. If I use 10% of my nil-rate band today, that's 10% of all future increases in the nil-rate band lost before second death, and that figure is always rising. It's well worth noting they have pointed out most of these increases in the nil-rate band on a few occasions, leading you to believe it's worth not using the nil-rate band now but keeping it for later.
Either way, for me nothing has changed and only those with 'muddy' estates near the double nil-rate band have a concern as they may be forced into making a decision one way or another to allow for increases - create a trust on first death or not?
For me those with estates of £500,000 or more should consider that quickly.
What we all have to remember is that trust planning also allows for succession and tax planning, using offshore bonds for example.
If you have set up a trust you could use an offshore portfolio bond, which allows for the underlying funds to grow free of tax (apart from a small element of withholding tax on dividends in certain scenarios). The underlying funds can be swapped and changed without any liability to tax.
Later the trustees can assign the bonds to non-taxpaying beneficiaries and encash. The gain is added to their income for the year and can be used to offset against normal income tax allowances.
We can therefore benefit from tax-free growth and tax-efficient distribution, while knowing the capital is outside the estate for care costs as well as IHT planning. By using the obvious discounted gift trust, we are still allowing access to 'income' as well as reducing the estate for the purposes of immediate gift calculations and the 10-year periodic charge calculation. So while more complicated in some ways, nothing has changed for the specialist adviser. n
Peter McGahan is managing director of Worldwide Financial Planning
DB and a lack of alignment
Encouraging better use of tech
Win one of three £20 Amazon vouchers
Vanguard's multi-asset range