Julie Hutchison assesses a recent case study and discusses the options for mitigating IHT
Sue and Ian Smith are in their mid 60s and recently retired. They have not yet downsized, as they have held-off putting their house on the market due to the slowdown in the housing market. When they do sell, they hope to release £200,000, which they plan to invest. They plan to purchase a house outright worth around £200,000.
They currently have wills which were written 15 years ago and came free when they bought their current house. They now have two grandchildren under the age of five, children of their daughter. Their son, who is in his 30s, is not married and lives in a small apartment.
Sue and Ian’s current net worth is around £750,000, of which £400,000 is currently tied-up in the house. The remainder is held in bank accounts and a share portfolio which they have had for many years. Sue has a solid civil service pension. Ian’s pension pot was a little disappointing due to market performance in recent years, and they are looking to increase their income once their house is sold. Ian recently consolidated his selection of pension plans into a SIPP.
Sue volunteers each week for her favoured charity, Macmillan Cancer Support. Neither Sue nor Ian have made lifetime gifts over and above amounts well within their annual allowances. Ian made a loan of £15,000 to their son to help with the deposit on his apartment. Ian does not really intend to call-in that loan.
Reflections on the estate planning issues arising
This will be a multi-stage process for Sue and Ian. Stage one involves getting their affairs in order based on them not selling the house for the moment. Stage two will be to revisit their estate planning, if and when, they do downsize.
Assuming they both have full nil rate bands available for IHT, their estate planning could involve a transferable nil rate band, so that the IHT calculation would be: 750,000 - 650,000 = 100,000. IHT at the rate of 40% results in an IHT liability on second death of £40,000, based on current figures.
A simple, but rather brutal, way of eliminating their IHT liability would be for them to reduce the value of their combined estates to below £650,000, by giving away more than £100,000.
This does not seem quite practical at the moment, as Ian has said he wants to increase his income over time, and their wealth is tied-up in their house. It is an option to be considered, however, and much depends on their appetite to mitigate IHT.
They should make arrangements to create new wills. This will allow them to make proper provision for their grandchildren, as they may wish to create trusts to hold any assets which may otherwise end up in their young hands in the unfortunate event of the premature death of their daughter. A discretionary trust for grandchildren in their wills might be worth considering here.
Ian could also add a clause to his will ‘forgiving’ the debt relating to the loan to his son. This would mean his son would not need to repay it.
Lasting Powers of Attorney would also be a sensible measure, to provide a mechanism by which their finances could still be administered in the event of their declining health.
Depending on the nature of the withdrawals Ian is taking from his pension, there may still be scope to leave an Expression of Wish form in relation to lump sum death benefits. The use of a discretionary trust to hold such a lump sum (a so-called ‘Bypass Trust’), as an alternative to its direct payment to Sue, is worth considering, as a means of preventing its value being aggregated with Sue’s estate and increasing the ultimate IHT bill. This would also be a sensible longer term asset protection measure, as Sue could still have access (possibly by way of interest-free loans), but the overall value of the lump sum would not be added to her estate.
Sue may also want to consider leaving a legacy to her favoured charity in her will. This would be free of IHT.
As and when their house is sold and their liquidity position changes, they may wish to consider making use of the IHT annual exemption (£3,000) to make gifts each year. Depending on their income levels, regular gifts from surplus income may also be feasible at that time.
This case study does not constitute legal advice. It is indicative of some of the options available and a full fact-find would be required to assess suitability of any solutions. Tax and legislation can change in the future.
Julie Hutchison is head of estate planning at Standard Life group
Has run Cautious Managed fund since 2011
What’s right – not what sells
Richards fires back at committee report
Available on Investcentre platform
Invested from 2006-2011