John and Sarah Watson are a married couple in their late 60s and have both recently retired. They live in their former council house, which they bought jointly in 1982 under the right to buy scheme. It is now worth £450,000. They have a son and daughter, both of whom are married, financially independent and with children of their own.
John and Sarah are very grateful for the fact that they have been able to retire on final salary based pensions from their former employers. These give John an annual income of £12,000 while Sarah has £10,750. They are particularly pleased that the tax-free cash taken out of the schemes when they retired has allowed them to purchase a small holiday apartment in Spain for £80,000. Furthermore their pension income and the availability of cheap flights allow them to make 2-3 trips to the apartment each year.
The couple have led a modest lifestyle and have been careful with their money, such that over the years they paid off the mortgage on the family home and have built up nest-eggs in PEP and ISA plans worth £107,000 for John and £62,000 for Sarah. The couple also have combined building society savings of £29,000 while house contents and their car have been estimated to be worth £25,000.
John has also saved into an FSAVC and later a stakeholder pension plan. These pots now total £65,000. When he retired recently he stopped contributing to the stakeholder, but did not immediately take any income from these plans as he felt that the occupational pension income would be sufficient for the time being.
Now that they have both been retired for a few years, John and Sarah think that it is a good time to review their financial position, as they are now confident that they have sufficient income to maintain a comfortable lifestyle. They are concerned that they have never written wills, and realise having reached retirement and with the grandchildren growing rapidly that they should be thinking about estate planning.
They have therefore contacted their IFA for advice on what to do with John's personal pension plans and for ideas to mitigate their inheritance tax position.
Norma Haynes is a financial planning technician at Lucas Fettes and Partners
Based on disclosed assets, the assumption that unvested pension plans have no nominations in place and no nil rate band (NRB) trusts have been set up, on the second death now the survivor's estate would be liable at first glance for an illustrative inheritance tax charge of £207,200 (£818,000 - £300,000 x 40%).
Final salary arrangements and unvested personal pension plans are not at a level that would cause them to breach their lifetime allowances. Unvested pension arrangements would provide additional tax free cash, however, additional income/cash is not required. The current pension income provides inflation protection and crystalising the FSAVC/stakeholder would simply increase the immediate estate. Nominations of benefit should be put in place on unvested FSAVC and stakeholder plans (ideally to his children) and leave the plans unvested until 75. On death prior to age 75 the full fund value can be paid out to the nominated beneficiary free of IHT.
For the years post 75, John could forego tax free cash and buy a joint life pension with spouse benefits - passing surplus income to his beneficiaries under regular gifts from income exemption facility and annual allowances. They should engage a solicitor to draw up wills, move the ownership of their main residence from joint tenants to tenants in common and simultaneously set up nil rate band trusts. On first death 50% of the value of their main residence (plus additional capital) could pass into the NRB trust, using up one full £300,000 allowance to fall outside the survivor's estate on the second death. The Spanish property is infrequently used and appears to generate no income - so consider sale at some point. There is no ability in Spain for a jointly owned property to pass tax-free to the survivor on first death - therefore a considerable Spanish tax charge would arise and must be paid by the survivor (or inheritor) within 3-6 months. Properties cannot be sold to cover taxes, this re-enforces the use of exemptions to pass funds to non spouse beneficiaries to cover the eventual tax burden. Resultant current IHT on second death (after £300,000 to NRB and nominations) circa £61,200 (£453,000 - £300,000 x 40%). This is assuming the estate is now subject to UK tax only. To reduce liability further pass £6,000 pa (£3,000 each) to children or grandchildren via exemptions plus use regular gift from income exemptions to pass unlimited sums, providing this has no adverse effect on their standard of living.
Jacqui Davidson-Slack is a senior consultant at IFG Financial Services
I recommend valuations of FSAVC and the stakeholder pensions as well as the PEPs and ISAs to ensure they are performing satisfactorily. If they are not then the situation can be reviewed and appropriate advice given.
Some of the surplus income could be used to help mitigate any potential IHT. They can dispose of up to £300,000 each on their death and possibly more in their lifetimes.
It is imperative that they write wills, dying intestate is time consuming, costly and stressful and may mean that their estates are not settled in accordance to their wishes. They should both consider setting up enduring powers of attorney (EPA) particularly as the Government proposes replacing EPA with lasting powers of attorney (LPA) in October, a more costly and fiddly alternative.
Most couples still leave on death their entire estate to each other which means they are not making use of their nil band rate of £300,000 (2007-08). One consideration would be to leave as much cash as possible on either death to their children or grandchildren.
They might consider becoming joint tenants in common. This way John and Sarah each own half the value each and on either death this can be left to a beneficiary, with a loan agreement drawn up on a commercial basis. It has the added benefit, potentially, of not being used in the assessment for contributions towards any future nursing home fees. Using a portion (up to the nil band rate) of equity in the property to reduce IHT means that the Watsons can pass some capital to each other without leaving each other "short".
They could also consider an equity release scheme designed for IHT purposes, a discounted gift scheme or a sophisticated bespoke deal. The property could be sold to a specialist company in return for a lump sum, part of which would then be used to pay for a lifetime rent in advance, the remainder being invested under trust with a guaranteed return on the second death - to be paid outside the estate on death with no IHT implications. Stakeholder pensions could be set up for the grandchildren and the annual exemption could be given away.
A record of all gifts and arrangements would help the executor considerably.
There may be an issue over the Spanish property and the way IHT is assessed on worldwide assets. Specialist advice is needed here.
Finally, a whole of life insurance joint second death policy to cover any IHT payable on second death could be considered, funded by his FSAVC benefits and stakeholder income.
Finally they could spend more on themselves and their family!
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