Are you an IHT Planner or have you waited to the last minute?
Tax Avoidance Schemes hit the headlines last week as two high profile stars Messer’s Jimmy Carr and Gary Barlow got caught up public fury. The general consensus against the low (virtual non-payment) of income tax appeared to be not only to be ‘anti’ but upped the ‘anti’ to such an extent Mr Carr quickly back-tracked sighting an ‘error of judgement’ on his behalf.
Whatever your view on Tax Avoidance Schemes they are here to stay. Every piece of legislation has daylight in it and often the spin of ‘investment income’ into a ‘loan’ coupled with a suitable vehicle which is often situated outside the UK to make it achievable. The tax avoidance product designers are normally one step ahead of HMRC and present a ‘window of opportunity’ for the investor to exploit. Entry into schemes can come with the threat of HRMC retrospectively applying action but examples of this happening are few and far between and actually there is little downside, just the loss (or more technically correct, ‘repayment’) of the upside.
Today, I want to touch on Inheritance Tax in the context of tax avoidance. In my view you have achieved good ‘financial planning’ when you can go under a bus tomorrow and know that your affairs are in order. As Estate Executors will testify there is nothing worse than a financial mess to tidy on top of the stress of loosing a loved one. These Executors in the majority of cases are next kin, that’s right your spouse or children. Worse still in my opinion is leaving a liability. It could be argued ‘who cares I’m dead’, if that is your belief I would stop reading now.
Let’s start by going back to basics. Everyone is entitled to a monetary value before inheritance tax is due. This is lovingly referred to as the ‘Nil Rate Band’. It currently this sits at £325,000 (2011/12) and will remain unchanged until 5 April 2015 as the Government seek to take in more coffers to repair the economic damage. Over this figure inheritance tax is charged at 40% (2011/12). In the case of a married or civil partnership couple any unused portion (percentage wise) can be transferred to the spouse on first death. The percentage will then by applied to bolster the estate’s entitlement on second death.
As Niche Advice is based in London the majority of our clients use this allowance straight off the bat on their main residential home, leaving a gaping liability for their children.
If we ignore ‘gifting assets’ out of your Estate as a method of IHT mitigation (details on this subject can be found on my past articles on this site), how do you approach the IHT conundrum?
Well you can fall into two IHT camps, ‘traditionalist’ or ‘gambler’. The two paths rarely cross but potentially could.
The IHT Traditionalist requires certainty and would look to the tried and tested methods that have worked down the years such as whole of life insurance which pays a lump sum on second death to clear the IHT liability. It is perhaps bland in some people’s eyes but as it is offered by some of the largest institutions in the world, importantly has no heat from HRMC, and it certainly has its place.
With investment performance low in recent times a new breed of whole of life plan has emerged that is not dependent on investment returns, which are worth considering for the cautious.
To the untrained eye some would view whole of life insurance as expensive but if you can prove to HMRC that you pay the premiums out of ‘normal expenditure’ then you are affecting ‘gifting’ these premiums out of estate in a tax efficient manner (the justification can be relatively straight-forward, a standard order over a period of time normally does the trick). Furthermore there is often the option of ‘reviewable premiums’ rather than ‘guaranteed premiums’ for clients who ideally want to keep initial costs down, but recognise their payments may have to increase in the future. Depending on the whole of life plan you might be able to drop the ‘surrender value’ option to reduce the premium outlay – a sensible trade if you are committed to using the policy, as intended, for inheritance tax purposes.
Some of the whole of life plans that Niche Advice offers also have the built-in ability to increase the sum assured (lump sum payment on death) if the Nil Rate Banding is adjusted by the Government without the need for further underwriting or indeed adjust for lifestyle changes such as children, marriage, new home, divorce or job promotion.
The IHT Gambler will look to exploit the Business Property Relief Tax rules, Agricultural Property Relief rules and Woodlands Relief rules. In the case of the former two, they are a set of rules laid out in legislation which seeks to provide a tax advantage to continue and preserve certain business assets down through the generations so businesses can continue to trade. For the latter it is a special relief for growing timber in the UK or EEA. All three have the ability to avoid inheritance tax when utilised correctly.
Business Property Relief is the most common used of the three. The main stipulation being the property must have been owned for two years prior to death. This is where the IHT Gambler tag comes into play as you would probably choose to delay converting your Estate into qualifying assets until the last opportunity. If you die within two years the plan is in disarray. There could also be a legislative change removing or adapting these reliefs.
In the past strategic IHT planners would have formed their own companies to achieve IHT avoidance this way – for want of a better expression a ‘shell company’ would be formed. However, times have moved on and commoditised, and now you can invest in funds that have multiple qualifying assets (or businesses) to spread the risk. The funds will also make investments in asset backed investments and VCT qualifying companies that are issuing new shares on AIM and will look to provide an income or growth as well. After the two years the investment would normally be transferred into a discretionary trust. The trust can then be used to provide an income, for say school fees, and will prevent the need to go through the probate process. If utilised correctly the IHT disappears completely – hey presto! All you now need to deal with is the media or Prime Minister at your door asking whether is it ‘morally acceptable!’
To find out more about Whole of Life Plans or advanced IHT Solutions and Tax Avoidance Schemes call 020 7993 2044.
Richard Stokes is a partner at Niche Advice Ltd who are Independent Financial and Mortgage Advisers in London.
Author: Richard Stokes
Richard Stokes is a partner at Niche Advice who are whole of the market Independent Finance Brokers In London. His role is very much focused on on Mortgage and Insurance products.