Gerry Brown discusses inheritance tax planning
Do you feel the general public is now more aware of the need to make inheritance tax provisions?
The general public's awareness of inheritance tax and its impact on family wealth has increased significantly over the past 15 years. Additionally, some of the common techniques used to mitigate the impact of the tax have become widely known. This is largely due to press comment, particularly in the personal finance sections of national newspapers. The juxtaposition of double digit house price inflation and modest increases in the inheritance tax nil rate band was a much used, and very effective tool in raising public awareness.
Another factor has been the publicity given to high profile court cases; in particular, the 'adventures' of the Burden sisters at the European Court of Justice.
Investing in AIM markets allows people to mitigate inheritance tax liability after two years. However, how has investment market volatility affected people's willingness to adopt this approach?
Investments in qualifying AIM trading companies can attract 100% relief from inheritance tax provided the investment is held for at least two years before a chargeable transfer occurs. For this purpose a trading company is one whose trading activities exceed 50% of its total activities.
There are no 'reservation of benefit' issues - the investor can keep dividends. Additionally, and perhaps more importantly, if the investor needs cash, the portfolio can be liquidated, wholly or partly. Any part remaining invested continues to qualify for inheritance tax relief. The key lies in minimising investment risk and expert investment advice is essential.
What are the pros and cons of different trust structures?
Inheritance tax planning ensures that estate planning is carried out in such a way that the Government does not become a major beneficiary of the client's estate.
Successful estate and inheritance tax planning always involves a strategy of gifting assets to succeeding generations. The use of trusts ensures that gifting is undertaken in a controlled way - although the settlor has made a gift (to the trustees), no particular beneficiary can call the gifted assets his or her own. The trustees must at some point pass the trust fund to the beneficiaries, though obviously this can be done in stages. The trustees often have a choice as to which beneficiaries will benefit, when, and to what extent.
What factors do advisers need to bear in mind when choosing a trust structure for clients?
The key factor is that the trust structure chosen must meet the client's needs.
If a client wishes to make an outright gift without any further access to the gifted capital, then a gift trust, discretionary or absolute, will meet the needs of the situation. The trust is being used to introduce and maintain 'control' over the gift. Consideration needs to be given as to the tax consequences of this approach. Gifts to discretionary trusts in excess of the available nil rate band will trigger chargeable lifetime transfers; gifts to absolute trusts will be potentially exempt transfers. Current practice seems to be that, where the flexibility of a discretionary trust structure is needed, gifts are kept within the available nil rate band.
If future access is required, then the nature of such access needs to be established. If the client wishes to have future access to all current capital, a loan trust would be the preferred choice. If, however, the client is happy with access in the form of a pre-set (and unchangeable) payment stream, a discounted gift trust would generally be the preferred vehicle.
How easy is it to amend a trust once it is made? What options are available to advisers should changes need to be made?
The trusts commonly used in inheritance tax planning strategies are irrevocable - once set up they cannot be 'undone' or 'cancelled'.
Having said that, most modern trusts are designed with flexibility as the paramount feature. Many trusts have what is known as a trustees' power of appointment. This gives the trustees the power to rewrite the terms of the trust, subject to a few important restrictions. A well drafted trust will be able to accommodate most changes of circumstances. In extreme situations it may be necessary to apply to the Court seeking a variation to the terms of the trust.
What are the common mistakes people make when dealing with tax and trusts?
Those involved must have an appreciation of the rationale behind the trust. The trustees have overall responsibility for administration of the trust and the eventual distribution of trust assets. These are onerous responsibilities and the trustees should appreciate this fact. Many mistakes are made because the trustees do not actively fulfil their role. The trustees owe their duties to the beneficiaries and not to the settlor. They should use their own judgement and not simply follow the settlor's wishes or instructions.
Trustees should ensure that the investments are reviewed on a regular basis and should consider changing underperforming assets. Trustees should take investment advice where appropriate. Beneficiaries - unhappy with the performance of the trust fund - may take legal action against the trustees and it is vital, if claims for compensation against the trustees are to be defeated, that accurate records of the advice received and decisions taken are maintained.
Gerry Brown is manager - tax & trusts at Prudential
Gerry has responsibility for Prudential's onshore and offshore inheritance tax solutions. A chartered accountant and member of the Society of Trust and Estate Practitioners (STEP) Gerry is one of the industry's foremost IHT and trust experts.
About Prudential International
Based in Dublin, Prudential International is part of the Prudential Group, one of the UK's foremost financial services organisations. The Group has over 21 million customers worldwide, for whom it manages over £256 billion (as at June 2008).
Joined as head of strategy, multi asset, in June
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