Paul Latham discusses inheritance tax mitigation strategies
Thanks to current inheritance tax (IHT) rules, the taxman is able to lay claim to a sizeable chunk of the value of an individual’s estate when he or she dies. Unfortunately, the current state of affairs is unlikely to change any time soon.
Before the 2010 General Election, the then Shadow Chancellor George Osborne pledged that he would raise the IHT nil rate band to £1 million, effectively removing an IHT burden from a further four million Britons. Sadly the government’s austerity plans have meant the pledge has been abandoned.
Recently it was announced that the government plans to keep the nil rate band frozen at its current level until April 2018 at the earliest.
As a result there is a likelihood that demand for products that mitigate or even eliminate IHT liabilities will increase significantly as more people realise that the government has no intention of raising the nil rate band.
Discounted gift trusts
One of the most popular IHT solutions available in the marketplace is the discounted gift trust (DGT). With a DGT, HM Revenue & Customs places no limit on the amount that a person can invest. The effective limit is the nil rate band, and you don’t have to ‘gift’ your money to family members or organisations to obtain tax breaks.
A DGT also allows you to continue to receive tax-deferred income from the investment during your lifetime, at a pre-determined level that suits you.What’s more, part of your investment will be exempt from inheritance tax immediately.
However, DGTs do have certain limitations. For many people, a DGT takes too long before it becomes fully IHT exempt. Although there’s some immediate relief, part of the investment made into traditional DGTs does not fall outside of the taxable estate until seven years have passed and uses up part of the nil rate band in the meantime.
This means that the investor remains liable to IHT if they die within that time period. For many elderly clients, seven years is simply too long to wait. Also, those with health problems are unlikely to receive from HMRC the ‘discount’ that gives the immediate IHT benefit.
Using business property relief for IHT planning
So, what are the options open to clients interested in the IHT advantages of a DGT, but can’t afford to wait a full seven years? Well there is an alternative solution which uses a tax incentive called business property relief (BPR). It can be used as a way for investors to effectively speed up the timescale for getting full IHT exemption on their investment, but without losing control over their money.
BPR was created to allow small businesses to be passed down through generations without incurring an IHT liability. Its scope has been widened in subsequent years, making it significantly more attractive to private investors looking to address potential inheritance tax liabilities. However, its greatest assets are speed, simplicity and control. Rather than having to wait a full seven years for IHT exemption, BPR rules mean that any qualifying investments benefit from 100% IHT relief, after just two years. Qualifying investments include unquoted UK businesses, and shares in trading companies quoted on the Alternative Investment Market (AIM).
Inheritance tax solutions using BPR also deliver several other benefits over and above a traditional DGT. For example, the use of BPR can ensure investors retain access to their investment, allowing them to build capital value, take a regular income, or to dispose of their holding if circumstances change.
In addition, such BPR-based products have been structured to allow investment into a portfolio of BPR qualifying companies without involving complex legal structures, client underwriting or medical surveys, as would be required to invest in a DGT. This includes the ability to transfer between spouses, following the death of the first spouse, without ‘resetting the clock’ on the two-year BPR qualification period. As a result, within a marriage or civil partnership, only one spouse or partner needs to survive for two years for their BPR-based investment to be exempt from IHT.
DGTs, and investment solutions that use BPR to further speed up the process of reducing IHT liabilities, both have an invaluable role to play, particularly at a time when current IHT laws seem to unfairly penalise a vast number of people who aren’t especially wealthy. It doesn’t have to be like this.
With the right financial planning, practically everyone with an IHT liability should be able to reduce or eliminate it. If you, as an adviser, haven’t already sat down with your clients to have a serious talk about IHT planning for them and their parents, isn’t it time you did?
Paul Latham is managing director of Octopus Investments
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