IHT Planning

Talking about Inheritance Tax (IHT) (which we weren’t!) it’s now been almost ten years since the nil rate band (NRB) was changed, staying at £325,000 since 2009.

But we are in a very different world than 10 years ago and the size of many people’s estates has grown dramatically.  It’s no surprise therefore that the amount of IHT being paid has substantially increased.

According to HMRC statistics, the number of people with estates worth over £1m has almost doubled in the last ten years alone, whereas the NRB allowance continues on at the same level

Where are IHT tax revenues coming from?

House price growth is probably one source of this wealth and the fact that we’ve had a bull market for around a decade will only have increased wealth as well.

As a consequence, the Government’s revenues from IHT are predicted to grow in an almost linear fashion.  Nevertheless the Government is pondering inheritance tax simplification

So why reform the system?   Isn’t more IHT a good thing for the Government’s coffers ? Greater revenue to go on schools, hospitals etc.  But,  is it right that, after working all your life and paying taxes, your estate might need to be broken up on death to pay yet another tax?

Particularly when the NRB allowance doesn’t increase and hence becomes more and more irrelevant.

But what’s the answer? Indexation of the NRB in line with inflation, as is planned to happen from April 2021, would at least be a start; perhaps an even better way would be to link it to average estate size.

IHT has a number of exemptions, perhaps the most useful being the normal expenditure exemption. This allows regular gifts to be made out of income and, provided that the gifts do not reduce the donor’s usual standard of living, there is no limit to the amount that will be immediately exempt.

There is no need to wait for seven years and the amount that can be given away each year can increase as excess income increases.  But what if gifts have to be made from capital, not income?

The NRB is available during lifetime, not just on death.  With forward planning, it can effectively be recycled by gifting capital every seven years.  Using this strategy can remove a great deal of wealth from the estate very tax efficiently.  But, in an uncertain world, can taxpayers afford to give assets away?

The reality is that the market is finding workarounds to the limitations of the NRB. Trusts are a particularly common solution. Used the right way, these can often serve two masters – potentially allowing access to capital while creating a timetable to have funds outside the estate within a set period.

With an increasing lifespan, many clients are right to be wary of entirely signing away their estate beforehand, no matter the IHT efficiencies. Discounted gift trusts, flexible reversionary trusts and gift and loan trusts all offer some trade-off between IHT efficiency and access. Depending on the clients’ needs, these can help ensure an IHT strategy that suits their needs.

 

Tax Diversification also?

The respected Tax Adviser Danby Bloch has recently stated that diversification is not just an important strategy for investment – it also makes sense when it comes to tax planning.

And with the current low level of new business flowing into life assurance bonds, maybe this a way of mitigating Inheritance Tax which has been forgotten about.  Only about 3 per cent of assets on adviser platforms is held in the form of UK or offshore bonds, according to recent Platforum research.

Unsurprisingly, the main focus of inheritance tax planning is on pensions and business property relief (BPR) investment. And there are good reasons for their popularity, seeing as they provide the irresistible and currently politically-fashionable attraction of both having your cake and eating it.

You can hold on to the asset in your estate and access it for spending if the need arises but it is free of IHT at the same time.

There is, of course, a requisite two-year wait for a BPR investment to qualify for IHT freedom, although that does not normally present a serious problem for most clients.

What could be better than that?  Not much.

Even if the original investor takes a relatively short-term view, their beneficiaries may well be able to weather investment storms and sail through to better times and returns.

Pensions are currently IHT-free on death, although the age at death means there is something of a tax lottery. Still, the underlying investments should be more mainstream and less volatile, especially with a foundation of fixed interest.

What is not to like, however, is that neither of these tax privileges are guaranteed to survive a Labour government or even the current chancellor, who has set the Office of Tax Simplification to review IHT.  The OTS has asked interested parties for their views on a whole range of issues, including BPR, pensions and life assurance.

Bloch is of the view that the current structure of BPR is very generous by international standards. And while there are some solid reasons it might possibly survive in its current form, things can change quickly.

Family businesses are arguably the backbone of UK enterprise, so encouraging them to take an intergenerational long-term view makes a lot of sense for the government. But some would argue these reliefs can also stultify enterprise and reinforce social immobility and privilege. The tax breaks have survived several decades of different governments but they might not continue to be so generous in the future.