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Tax Planning

Tips When Using Trusts for Inheritance Tax Planning

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Inheritance Tax is still a concern for many families, despite the new Main Residence Nil Rate Band adding up to £350,000 to the standard IHT threshold.

Making gifts or using Trusts usually take seven years to become completely free from Inheritance Tax (IHT). But an investment in a Business Property Relief (BPR) qualifying company can be passed down to beneficiaries free of IHT on the death of the shareholder, provided it has been held for at least two years at that time.

At FAS, we are strong advocates of using Trusts as well as BPR investments to mitigate a potential IHT liability and always give full consideration to both options when discussing Inheritance Tax Planning with our clients.

 

Don’t Give Away More Than You Can Afford

Trusts are a specialist planning tool that may not be suitable for everyone. We have prepared this guide to address some common questions, concerns and pitfalls that can arise when considering Trusts.

Remember, a Trust is a completely separate legal entity. Once you have gifted an asset into a Trust, it is no longer yours. In most cases, you cannot receive any benefit from the asset.

If you are thinking about gifting money into Trust, think about how much you would be prepared to give away without the Trust structure.

The main benefit of a Trust is that it gives you some control over how and when the gift is distributed. So, if you’re sure that you want to set aside £100,000 for your grandchildren, but don’t want them to receive it as a single lump sum when they turn 18, a Trust could be the answer.

But if there is a chance you will need the £100,000 to pay care home fees, a straightforward Trust won’t help with this.

There are certain Trusts which allow you to retain some access to the capital or to draw an income. These are known as Gift and Loan Trusts and Discounted Gift Trusts. However, these carry some restrictions, and may not be as effective for IHT purposes as a full Trust.

Trustee investments should be considered as part of your wider financial plan. A simple cashflow projection can help you decide how much you can afford (and are prepared) to give away.

 

It’s Not Just for Gifts

A Trust can be set up even if you don’t have any money to gift.

The simplest way to use Trusts in IHT planning is to ensure that your life insurance is payable into a Trust. This offers the following advantages:

  • No IHT when the benefits are paid out
  • No IHT on second death, as with the benefits in trust, the surviving spouse’s Estate has not increased in value
  • Benefits are paid out more quickly, bypassing probate procedures
  • Life policies can be set up for family protection, or specifically to cover an IHT liability.
  • Pension death benefits and employer death in service plans can also be paid into trust.

 

Absolute or Discretionary?

An Absolute Trust (or Bare Trust) works in the same way as a gift. The asset is earmarked absolutely for one or more beneficiaries under the terms of the Trust. There is no scope for the Trustees to apply their discretion.

This means that once the Trust is in place, you no longer have any control. However, the gift will drop out of your Estate after 7 years. The investment is taxed as if it belongs to the beneficiary.

A Discretionary Trust, as the name implies, allows more control over the investment. The Trustees can decide how and when to distribute the money. The beneficiaries can also be changed or selected from a particular group.

However, a Discretionary Trust offers certain disadvantages:

  • If the gift is over £325,000, IHT of 20% applies immediately. A further 20% is then due if you die within 7 years.
  • Further IHT charges apply every 10 years. This is broadly 6% of the value over £325,000, with adjustments made for any withdrawals taken.
  • Exit charges may also apply when money is distributed from the Trust.

These points can mostly be mitigated with proper planning. But considering that larger Trusts in particular may incur additional fees in respect of legal and tax advice, a Trust can prove very expensive.

 

IHT is Not the Only Tax

Discretionary Trusts are subject to higher rates of tax than individuals.

Income is taxed at 20% on the first £1,000 only. Thereafter, income is taxed at 45% – an individual would need to earn £150,000 before paying this rate of tax.

If the Trust realises a capital gain, the first £6,000 is exempt from tax. This is half of the allowance available to an individual investor. Any gains over this amount are taxed at 20%, the same rate payable by a higher rate taxpayer.

Detailed planning is required to make sure that the strategy works, taking all taxes and costs into account.

 

The Investment Strategy Matters

The portfolio selected for a Trust investment may be different from an individual’s own funds.

It could be appropriate to use a higher risk portfolio on a Trust, to maximise the growth potential so that the money can last for several generations. Alternatively, the money might be required in the short term to provide an income, in which case a lower risk strategy would be suitable.

Taxation is an important factor. Using an Investment Bond as a wrapper for the investments can be effective, as there are no tax implications unless money is actually withdrawn. This means that funds can be switched within the bond without worrying about Capital Gains Tax. Similarly, interest and dividends produced within the funds are not only free of tax, but do not need to be declared on a tax return.

Bond withdrawals can result in unintended tax consequences, so it is always best to speak to one of our Financial Planners before proceeding.

A Trust can be an effective way of mitigating an Inheritance Tax liability, but you should always take financial (and sometimes legal) advice to ensure it is the right course of action.

Please do not hesitate to contact a member of the team if you would like to find out more about Inheritance Tax Planning.

How to Ensure Your Wealth Passes to Your Loved Ones

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Keeping wealth within the family is desirable but not always easy to plan. There is a myriad of Inheritance Tax (IHT) rules to mitigate and these are often complicated and subject to change. As Financial Planners, we are here to help clients navigate this complex landscape and leave a meaningful legacy for their loved ones, without paying unnecessary tax.

In this short guide, our financial planning team will be sharing some ideas on how clients with complex estates can leave their wealth to younger generations.

 

The Nil-Rate Band

The Inheritance Tax (IHT) threshold, also known as the nil-rate band (NRB) refers to the threshold after which you start paying IHT (usually 40%) on the value of your estate. In the 2019-20 tax year, this is set at £325,000 and includes the value of your home. So, if your estate is worth £500,000 when you die, then £175,000 is potentially liable to be taxed at 40%.

However, there are a number of IHT rules which can affect your threshold, and how much you pay. First of all, married couples and civil partnerships can inherit any unused IHT allowance from their deceased spouse. If they have not previously used any of this allowance, then the surviving spouse can effectively “double” their IHT threshold to £650,000.

Secondly, there is also an important caveat regarding your home. If you pass on your family home to direct descendants (e.g. children or grandchildren) when you die, then you can raise your IHT-free threshold using an additional nil-rate band (ANRB). In 2019-20, this allows each individual to pass on an extra £150,000, tax-free.

Again, married couples and civil partners can combine their ANRBs to potentially shield £300,000 of property value from the tax man. It’s also worth noting that this threshold will be raised to £175,000 in April 2020, which could allow couples to pass a £1m estate to their direct descendants completely free of IHT. For many people living in the South East this is welcome news in light of rising property prices, which might have tipped their estate over the IHT bar.

 

Pensions

It may sound strange to focus on pensions in an article about estate planning, but they can be a vital tax-saving tool. Under current rules, your pension is excluded from the value of your estate for IHT purposes, allowing you to potentially pass hundreds of thousands of pounds to your loved ones without these funds being potentially liable to IHT.

However, you do need to be careful with this and we recommend speaking to one of our experienced financial planners to ensure your pension is properly integrated into your estate plan. For instance, final salary pensions rarely (if ever) can be inherited by children, although there are often reduced benefits for a surviving spouse. Your state pension, moreover, cannot be passed down to your children or to your husband, wife or partner.

It is those with defined contribution pensions who can primarily make use of this part of the IHT system. Even then, however, there can be tax implications. If you die before the age of 75, for example, then under current rules your beneficiaries can receive any pension funds tax-free. If you die after this age, however, then it might affect their Income Tax bill (possibly pushing them into a higher tax bracket).

 

Other areas

There are a range of other IHT-mitigation tactics open to people with complex estates, depending on your personal circumstances:

  • For those interested in small businesses or startup investing, the Enterprise Investment Scheme (EIS) may be worthwhile considering. Here, you can invest up to £1m per tax year into EIS-qualifying companies and receive up to 30% tax relief against your Income Tax bill. Provided you hold your EIS shares for at least two years, these can also be passed down to beneficiaries, IHT-free.
  • Trusts can be a great way to reduce IHT whilst retaining a degree of control over your assets. Not only can this help to protect your child’s legacy if your surviving partner decides to later remarry, a Trust can help you control how the money is spent on you children and grandchildren. However, make sure you seek independent financial advice before committing to a Trust, as these come in different forms with a variety of rules.
  • Life insurance is also an option to consider, as the payout from your policy can be used to cover a potential future IHT bill. Bear in mind that you need careful financial planning if you are considering this, as the insurance policy itself can be included in the valuation of your estate (e.g. if it is not properly written into a Trust). You also should speak to us to ensure whether an insurance policy makes financial sense for you. In some cases, it might be cheaper to simply pay the future IHT bill than pay for the policy.

Do give us a call if you wish to discuss this area of advice in more detail!