Inheritance Tax Planning

Inheritance Tax (IHT) is a sensitive subject and one that you should be considering and thinking about even throughout the early stages of your lifetime. Your early years are deemed your accumulation phase as this is where you will see the majority of your wealth building.

IHT can be due on an individual’s estate when they die if their estate is valued at more than their available nil rate band (£325,000 in 2019/20). Your NRB is reduced by any non-exempt transactions made in the seven years prior to death. A range of IHT exemption are available to reduce your IHT liability; I am going to discuss benefits and drawbacks of trust planning.

A trust is a way of managing assets (money, investments, land or buildings) for people. There are different types of trusts and each taxed differently.

Trusts involve:

  • the ‘settlor’ – the person who puts assets into a trust and stipulates the terms of the trust
  • the ‘trustee’ – the person who manages the trust and ensure compliance with the settlors wishes
  • the ‘beneficiary’ – the person(s) who benefits from the trust

Trusts are set up for a number of reasons, including:

  • to control and protect family assets
  • when someone’s too young to handle their affairs
  • when someone can’t handle their affairs because they’re incapacitated
  • to pass on assets while you’re still alive
  • to pass on assets when you die (a ‘will trust’)

Gifting to a Trust

Gifting to the trust has a tapering allowance against IHT, demonstrated through the following decreasing basis:

For an investment of £325,000 (maximum gift each 7 years without incurring a lifetime charge); your IHT liability would be £130,000 at 40%, if you gift it to a trust you would see the following reductions:

 Trust Options

Family Gift Trust (FGT)

Probably the most traditional method of reducing IHT liability, but still hugely popular and very effective having stood the test of time is a lump sum gift into a family gift trust. We feel this could be hugely beneficial to many individuals, as we could place some savings into this trust to start the 7-year clock and take it outside of your estate for IHT purposes. You can only gift up to the nil rate band in any 7 year cycle without incurring an immediate 20% IHT liability (lifetime rate).

Positives: Simple and traditional form of IHT mitigation.

Negatives: Seven Year clock must be survived, and the control of money is lost. 

Gifting Outside of Normal Expenditure

While the lump sum Family Gift Trust option mentioned above is certainly the most traditional and vanilla method of reducing an IHT liability, we will now move on to discussing more tailored uses of Trusts and allowances.

The first of these methods is “Gifting outside of Normal Expenditure”. With this method you would regularly and continuously use excess income to gift, there is no seven year clock. Assets gifted outside of your expenditure are considered immediately outside of your estate.

This option only allows for regular gifts to be made when they are from income and the value transferred leaves you with sufficient income to maintain your usual standard of living. It is particularly appropriate for high earning individuals who can afford to gift a larger amount on a regular basis.

Positives: No need for lump sum to be gifted away. This is a progressive method of IHT mitigation, and the money gifted is immediately outside of estate. 

Negatives: Control of money is lost.

Annual Allowance Gifting

Another key strategy is to utilise the individual annual exemption. The first £3,000 of an individual gift in a tax year is immediately exempt from IHT. The exemption can apply to transfers into trust as well as outright gifts. The exemption can cover a single gift or several gifts up to this amount. It can also cover the first part of a larger gift. Once the current tax year’s annual exemption has been used, it is possible to bring forward any unused annual exemption from the previous tax year.

Positives: Effective and efficient way of utilising an annual allowance.  

Negatives: Limited to £3,000 per year.

Flexible Loan Trust

This method is not as commonly used as the previous Trust strategies, however it continues to be a viable option, especially whereby a Lump Sum is looking to be gifted away, and an ongoing income is sought.

This method encompasses the following key steps:

  • Lump sum of money is loaned to a Trust
  • The Trusts invests this money inside an Investment Bond
  • As the money has been given as a loan, it effectively freezes the IHT liability on this amount.
  • All growth on the money invested belongs to the trust, and not to the lender.
  • The loan can then be paid off over time, ideally when income is required. Thus the money received back from the Trust would be used and not retained in the estate.

Overall, this can be an effective option in order to “freeze” ones IHT liability on a sum of money.

The Flexible Loan Trust is an effective estate-planning solution for clients who wish to achieve IHT savings over time and wish to have continued access to their original capital. Even though a discretionary trust is established, there are no immediate IHT consequences to consider. 

Positives: Allows growth to accrue on investable assets outside of the estate instead of building additional wealth.

Negatives: The capital used to loan to the trust falls back into the estate at the date of death.

If any of these options discussed are of interest to you or you are just starting to consider the impact IHT could have on you and your loved ones then please get in contact with us for a free initial consultation.

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