Inheritance tax (IHT) is levied on the value of a person’s estate at the time of their death. Often considered to be a tax on the wealthiest in our society, the statistics suggest otherwise.
Background
IHT is charged at 40% above the tax-free threshold, which is £325,000 for 2017/18. When discussing IHT with clients they are often astonished to hear that the tax is payable at a flat rate of 40% of the estate, rather than the tax being progressive. An additional nil-rate band was introduced in April earlier this year and applies to transfers on death of a main residence to a direct descendant. A direct descendant includes a child, step-child, adopted child or foster child of the deceased and their lineal descendants. The additional nil-rate band is set at £100,000 for 2017/18.
Options
The desire to consider inheritance tax planning often wanes when the issue of gifting large sums of capital is raised, as that is often perceived as unaffordable when clients are potentially faced with a significant bill for long term residential care. There is a huge amount of uncertainty over how much anyone will need to pay for care, and the current uncertainty leading up to the General Election is adding to this. A number of strategies have been heavily marketed by the Financial Services sector over recent years, including:
- Discounted gift trusts;
- Loan trusts; and
- Wealth preservation trusts.
The first and last of these involve a gift into trust which will require the donor to survive for seven years to be completely effective. Depending on the age and health of the individual the discounted gift trust will provide an immediate IHT saving related to the discount on the value of the gift which is deferred, as far as the recipient is concerned, until the death of the donor. A loan trust has no immediate IHT saving and is targeted at clients who do not have the nil-rate band available or who wish to retain full access to the capital being loaned to the trust, and the IHT saving is therefore limited to any growth in the value of the funds invested. The wealth preservation trust allows the donor access to some of the capital on an annual basis should it be required, but ad-hoc payments cannot be taken. There are therefore considerable restrictions on either the access to capital in these structures or the IHT benefits they offer. On the plus side, relatively modest sums can be invested. Anyone advising on IHT will tell you that clients often leave it until far too late in the day to consider IHT planning, and the prospect of surviving for seven years seems unlikely. Although there can be some IHT saved if potentially exempt transfers are made which exceed the nil-rate band and taper relief is then available on those gifts, that is often still seen as unacceptable to clients, especially if such gifts would trigger a Capital Gains Tax (CGT) charge. It may well be better to retain the CGT uplift on death rather than risking incurring a charge to both taxes if the client failed to survive for seven years.
Business Property Relief
Business Property Relief (BPR) could provide a solution for those clients with a limited life expectancy and a desire to retain access to capital to pay for care if necessary. The relief is available at a rate of 100% provided certain conditions are met, namely:
- The investment in the business has been held for two years on death;
- There is no binding contract for the sale of the business on death; and
- The underlying business is not a disqualifying activity, i.e. a business which is mainly one of the holding or making of investments, which would exclude property investment businesses.