9 August 2022

Guide to Inheritance Tax & Estate Planning and how you may be able to mitigate any liability – Part 2

News & Insights

Jordan Wheatley

Guide to Inheritance Tax & Estate Planning and how you may be able to mitigate any liability – Part 2

Estate Planning Options – what can you do?

  1. Lifetime Gift to a Discretionary/Flexible Trust

If you do not need access to an element of your capital, you could gift that capital into a discretionary trust. A trust is a legal arrangement you can create where the gifted asset is held by a trustee or group of trustees, for the ultimate benefit of a named third party (your beneficiary(s)).

With such a trust, you retain ongoing control over the direction of the capital, e.g. who the beneficiaries are when capital is allocated to beneficiaries and how much is distributed. You can also appoint extra trustees who can fulfil your wishes after death.

A gift into a discretionary trust is treated as a chargeable lifetime transfer (CLT). There would be no immediate tax to pay on cumulative chargeable lifetime transfers in the previous seven years up to the £325,000 limit.

There would also potentially be tax payable at subsequent 10-year anniversaries, or when capital is distributed from the trust. The maximum periodic/exit charge would be 6% of the excess over the nil rate band.

Gifts to individuals and to trusts can be effective elements of an estate planning strategy but if you gift capital, you reduce your wealth and potentially the income that you can generate. There are, however, options available that can provide you with an ongoing income if desired and, in certain cases, access to capital whilst also proving effective from an IHT perspective by reducing the value of your estate. These options tend to fall into two categories, trust-based and non-trust based investments.

  1. Trust-Based Investments

Insurance companies offer various products that can provide significant IHT savings for investors. The products are typically ‘investment bonds’ which will be contained within a trust. The trust and legal documentation can be prepared and provided by the insurance companies themselves without cost.

I have provided an overview of the two main types of trust below.

  • Loan Trusts

If you invest an element of your capital within a loan trust you can:

  • Ensure future investment growth on this capital is outside of your estate with no IHT to pay on it
  • Enjoy an ‘income’ by drawing on the loaned capital held within the trust.
  • Access and recall the capital that you loan.

This type of arrangement can be highly effective as a form of estate planning as it freezes the capital in your estate for IHT purposes but can also reduce the value of your estate without you having to give up control over the capital or lose the ability to derive an ‘income’ from that capital.

A loan trust arrangement is a long-standing, and highly effective means of gradually reducing the value of your estate over time (as long as the loan repayments are spent!) and ensuring future investment growth falls outside of your estate. It enables you to provide a fund for beneficiaries outside of your estate, retain control over the capital loaned and generate an income from that capital should you wish to do so.

  • Discounted Gift Trust

Again, this is a trust-based arrangement using an investment bond. The invested capital is used to provide you with a fixed level of income each year until death. A discounted gift trust essentially splits a capital investment into two elements, namely:

  1. A ‘discount’ element, the value of which falls immediately out of your estate for IHT purposes.
  2. A ‘gift’ element, the value of which falls out of your estate once you have survived seven years from the date the trust is established.

A discounted gift trust can achieve an IHT saving over a much shorter, accelerated period with an element of the investment falling out of your estate immediately (with the rest after seven years). The limitation of a discounted gift trust is that it cannot be unwound.

In comparison, a loan trust represents a more gradual form of longer-term estate planning. The key attraction of the loan trust is that it gives you security and control. Unlike an outright gift or transfer into trusts, you do not lose control over the capital loaned and can unwind the arrangement and have the outstanding balance of the loan repaid.

These two arrangements can also be used together as part of an overall estate planning strategy.

  1. Tax Incentivised Investments

There are types of investments that are advantageous from an estate planning perspective and do not involve the use of trusts. These investments typically focus on the use of Business Relief (BR) to ensure that any capital invested qualifies for 100% relief from IHT after two years.

There are no trusts involved here, so these arrangements can be viewed as simpler and more straightforward. Some types of Business Relief arrangements can also be used to generate an income.

In most cases, the underlying investments used within these arrangements are high risk. Some BR qualifying products will invest in private companies and/or those listed on the AIM market. These are smaller companies, quite often illiquid, that can be highly volatile with returns that fluctuate widely. Whilst these arrangements can be highly effective from an IHT perspective, investors need to be comfortable with the elevated levels of investment risk that typically come with them.

It is important to look at the underlying investments here and not just the tax advantages.

  1. Protection

The estate planning options outlined above all cover things you can do during your lifetime to mitigate an IHT liability on your estate.

An additional approach is to accept that there will be an IHT liability and arrange life assurance so that a lump sum is paid to your beneficiaries to help them pay the tax. This would involve taking out a whole of life policy to pay out a sum assured on death (on the death of the surviving spouse for married couples).

There is a cost for this life assurance, and that premium cost is higher than for a term assurance policy because there is a guaranteed payout under a whole of life policy. How attractive this is, depends on how long you live and how many years you will need to pay the premiums.

A number of unknown factors make it very difficult to predict and target any potential tax liability accurately, but life assurance can still serve a useful role in helping to provide your beneficiaries with capital promptly.

Any such policy should be written under a trust to ensure the benefit does not fall into your estate and to enable the proceeds to be immediately paid to your beneficiaries.

Inheritance Tax can be a complex subject and it is important to seek professional advice along the way from an Inheritance Tax and estate planning specialist. Five Wealth Ltd offer independent financial advice to a wide variety of clients, at various stages throughout their investment and retirement planning journey. If you feel that our expertise would be beneficial to you, please get in touch.

The information featured in this article is for your general information and use only and is not intended to address your particular requirements. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. It is based upon our understanding and interpretation of HRMC practice and current legislation Always obtain profession advice before entering into any new financial arrangement.

The Financial Conduct Authority does not regulate tax or estate planning. Levels, bases of and reliefs from taxation may be subject to change and their value depends on your individual circumstances. Some IHT planning solutions may put your capital at risk you may get back less than your originally invested.