Inheritance tax (IHT) rules could be about to change – again – meaning all those carefully devised wealth succession plans may need an overhaul.
This July the Office for Tax Simplification (OTS) released a second report into IHT – Simplifying the design of Inheritance Tax – which it hopes will make this ‘unpopular’ and ‘emotive’ tax charge more palatable and understandable.
At the same time, IHT provides much needed revenue to the government. Receipts from IHT hit a record £5.4 billion in 2018/19 and are forecast to reach £6.9 billion in 2023/24. While the OTS can only make recommendations rather than set legislation, the Chancellor – whomever that may be post-election – is likely to take a close look at the proposals when deciding future policy.
This means advisers may need to revisit some of their approaches to IHT planning to ensure clients’ wealth succession plans remain tax efficient.
The fundamental principles of IHT planning remain the same irrespective of the tax rules. The first rule is to start early; getting a plan in place as soon as possible can help maximise gifting exemptions and planning opportunities. The early stages of planning should ideally take account of all members of the family to fairly balance any planning actioned during lifetime with wealth transfer plans on death.
It is of course vital to determine how much income is required in retirement and how long this may need to last. As all advisers know all too well, this is complex since it involves an assessment of lifestyle, health and life expectancy, as well as taking account of the effect of inflation.
Once income requirement have been agreed and if surplus assets are available, IHT planning should be considered. There are several tax efficient ways to pass on assets, but these have different constraints and obligations, and the rules may yet change.
Often the simplest route to bypass a 40% IHT bill is to gift cash or assets. A person may be eligible for several IHT reliefs when making a gift during their lifetime, including the annual exemption of £3,000 and gifts from ‘normal expenditure out of surplus income’. For larger gifts to be fully exempt from IHT they must be made at least seven years before death.
The OTS proposes that the small gifts allowance, currently £250, is increased to a more meaningful figure. They also recommend replacing the annual gifts allowance and wedding gifts with a single, larger personal gifts allowance. Interestingly, the OTS suggests reducing the seven-year gift assessment period to five years. As just £7m of the total £4.4bn IHT netted in 2015/16 came from gifts people made more than five years before their death, this change would not make a great dent in government revenue.
Even if the rules on gifting are simplified, advisers should bear in mind that once an individual makes an outright gift, they would have to forfeit any future access or benefit to ensure the gift remains tax efficient.
A more complex option, but one that can offer greater protection and control, is to set up a trust. However, as with gifting, once the assets are in the trust the settlor will forfeit access. The rules surrounding trusts are likely to change, too. The OTS report states: ‘The IHT rules applicable to trusts are not straightforward. Most individuals do not understand how trusts are used and have no knowledge of how they are taxed. It is not uncommon for experienced advisors to make errors as the IHT charged on trusts is difficult to calculate’. Further, the government recently concluded a separate consultation into the taxation of trusts on which it is yet to report. Trusts, then, are another area advisers cannot take for granted when it comes to IHT planning.
An alternative tax efficient option is investing in assets that qualify for Business Relief (BR). BR is a longstanding piece of legislation that offers 100% IHT relief on qualifying assets that are held for two years and on death.
There are many restrictions for BR qualification, including shares cannot be publicly listed on any stock exchange and must be held in a company that trades rather than invests. Many companies listed on the Alternative Investments Market (AIM) qualify for BR and can be held within an ISA. Since BR shares held for more than two years qualify for IHT relief – at up to 100% – it allows investors a quick and easy route to limiting their tax burden.
Unlike trusts or gifting, BR shares allow individuals to keep control of their money, offering flexibility and the potential to benefit from investment growth. Further, they are not subject to the same lengthy seven-year wait which currently applies to many estate planning strategies.
The OTS has also cast its eye over BR and recommends that companies need to have 80% of their business dedicated to trading rather than the current ‘wholly or mainly’ rule, generally accepted as more than 50%. This proposed change is designed to align the qualifying rules for CGT reliefs with IHT reliefs. Any such change could impact investors’ existing portfolios – another reason why it is important potential investors select a well-established and proven BR provider who is able to work with these changes.
Since the nil rate band has been stubbornly stuck at £325,000 for more than a decade, anyone with an estate exceeding that figure could be liable for IHT. In response, the government introduced the Residence Nil Rate Band (RNRB), which allows homeowners an additional £150,000 before they are subject to IHT. From April next year it will be at the full rate of £175,000 per person. This is a useful additional allowance given that it has been increasingly difficult to engage in IHT planning with the main residence.
However there are restrictions to who can benefit from RNRB; the estate must be left to direct descendants and if the value of the estate is over £2 million then the additional allowance is tapered. Married couples leaving their assets to each other may transfer the RNRB to the surviving spouse allowing them to use up to twice the tax-free amounts available to a single individual. The OTS describes the RNRB as ‘one of the most complex areas of inheritance tax’ and one that is in desperate need of a rethink. Yet, since it is so new the government needs more time before it considers an update. In the meantime, the RNRB remains a useful – if somewhat complicated – way to manage IHT.
Unlike ISAs and other long-term savings which are liable to IHT, flexible pensions are a tax efficient way of passing money down through the generations. If the pension scheme member dies before age 75, their nominated beneficiaries will not have to pay any tax on withdrawals, whether as an income or lump sum. If the pension member dies after age 75, pension assets become taxable at the marginal rate of income tax of the recipient. Since 2015, freedom and choice legislation has made it easier for defined contribution pension savers to access their money from age 55, adding greater flexibility but also additional complexity. However, pension restrictions introduced in 2016 have imposed a lifetime allowance, limiting the pension pot size to just over £1 million, meaning some wealthy investors need to seek alternative solutions to pass on assets tax efficiently to beneficiaries.
While ISA holdings still form part of the taxable estate for IHT purposes, a surviving spouse or civil partner can inherit ISA funds from their deceased partner or make an additional ISA subscription up to the value of their deceased partner’s ISA holdings. It is possible to invest ISA funds in AIM listed companies that can qualify for 100% BR relief after two years of ownership.
However, the unequal treatment between ISAs and pensions has led the OTS to suggest that ‘changing this would simplify inheritance tax’. Yet again, this could be a further reason that advisers may need to revisit their advice to clients to ensure that the most tax efficient wrappers are used for their intergenerational wealth management strategies.
Finally, the life insurance sector offers a useful IHT planning option. Typically a whole of life insurance policy is purchased and arranged such that the pay-out goes into a trust, making it exempt from IHT. The pay-out can then be used to cover all or part of the IHT bill on the estate.
One of the additional OTS recommendations was that the process of arranging life policies in trust be simplified by making the proceeds of a life policy exempt from IHT, removing the need for them to be written in trust.
IHT planning has long been one of the most complex areas for financial planners and advisers, yet it is one for which relatively few individuals seek advice. Well over half (58%) of investors aged over 50 who use an Independent Financial Adviser have not asked them for IHT advice according to research conducted by TIME Investments, published last month. The OTS’s far reaching report offers hope for much needed simplification in this area, yet with so many other priorities for government when, and indeed if, those changes manifest is anyone’s guess.
This creates something of a challenge for advisers who need to guide clients through this challenging and sensitive area, knowing that the landscape may shift leaving initial plans obsolete. This does not mean that IHT planning should be put to one side since rule number one in this area is to start sooner rather than later. The key lies in providing flexibility to clients, allowing them to revise any strategies and make changes.
Effective IHT planning allows genuinely positive wealth transfer between the generations but it needs to be done carefully and with an understanding that nothing can be set in stone.
Top tips for effective intergenerational financial planning
Posted: 25/11/2019 Categories: Inheritance Tax, News, Press, TIME:Advance, TIME:AIM, TIME:CTC