Sandy and Suzie have recently retired and have secure income that more than meets their needs. In fact, they have £10,000 a year of disposable income. Their estate is valued at £2.1m, including a house worth £800,000, and they are seeking advice on how best to pass on the assets they have built up to their four children and six grandchildren.
The only previous inheritance tax planning they have done was to buy Aim shares five years ago, which are now worth £200,000. When they invested in these they were told they would be IHT exempt after two years.
They were pleased when they heard about the introduction of the residence nil rate band and the IHT threshold becoming £1m between them in 2020, as they expect to live for another 10 years at least based on their family longevity.
While Sandy and Suzie are correct in thinking business property relief means their Aim shares do not count for IHT, they do count towards tapering the RNRB. The RNRB tapers down for estates valued over £2m and this is solely based on the value of the estate less any debts or liabilities. So, while the Aim shares do save on their IHT bill, they count towards the RNRB reduction.
From 2020, assuming no growth in the estate, the survivor’s RNRB would be tapered down by £50,000. This would up their IHT bill from an expected £360,000 to £380,000.
An obvious option is to take out whole of life cover (held in trust) to mitigate the IHT bill. Sandy and Suzie are open to this and, as they are in good health, should be accepted on normal rates.
Gifting assets either as potentially exempt transfers or chargeable lifetime transfers could be done and, as long as they live for seven years after these are enacted, they are usually out of their estate. In fact, gifting the amount in excess of the taper would have an immediate reduction in IHT liability, as it would be outside the estate for the purpose of calculating the available RNRB.
However, in addition to any life cover, they would like to explore making the most of their allowances, exemptions and tax reliefs. All of their children and grandchildren are working. The children are higher rate taxpayers and the grandchildren are basic rate taxpayers.
The adviser asks Sandy and Suzie to double check pension contributions for their children and grandchildren will not create tax relief or annual allowance issues for them. A contribution by a third party is limited for tax relief purposes to 100 per cent of earnings, or £3,600 if higher. This is in addition to any contributions the pension scheme member makes themselves.
After checking, it is possible to make a £10,000 contribution to a pension for each of the four children and six grandchildren. The children are sufficiently into higher rate tax that the contribution would be fully in that tax band.
An effective rate of tax relief of 95 per cent (£95,000 of tax saved from a £100,000 gift) is not to be sniffed at
The 10 £10,000 contributions are paid into a relief at source pension for the recipients and they each get £2,500 tax relief added to this, so they all get £12,500 in a pension. The four children who are higher rate taxpayers are able to reclaim £2,500 each back in their tax returns as further tax relief.
This would not only restore the RNRB but provide extra tax relief for their children and help with retirement planning to boot.
Making a total of £100,000 in gifts will actually produce the below tax savings in 2020:
- Relief at source: £25,000
- Higher rate tax reclaims: £10,000
- IHT saving: £60,000
- Total tax saved: £95,000
Note the gifts were not made from the Aim shares, so as well as getting back the lost RNRB there is an additional 40 per cent of the £100,000 gift saved. This assumes second death happens in 2020.
Further gifting or will planning should be considered to maintain an estate value of less than £2m.
An effective rate of tax relief of 95 per cent (£95,000 of tax saved from a £100,000 gift) is not to be sniffed at. The gifts would be classed as PETs, so Sandy and Suzie would have to live for seven years for the additional £40,000 IHT saving to apply.
Interestingly, even if the PETs fail, these are not in their estate on death, meaning there would be no tapering of the RNRB, so £20,000 of IHT would be saved regardless. Worst case, then, this would be an effective rate of tax relief of 55 per cent.
Additionally, they can make gifts from their disposable income (after the whole of life premiums, which for £320,000 of cover – the IHT bill post the £100,000 of gifts – would be approximately £500 per month).
They could even possibly fund £3,600 gross each a year to a pension to benefit from the IHT-friendly nature of these. They would only have to live two years for the pension contributions to be IHT exempt.
Lastly, the adviser now has an introduction to their family to help them on their journeys through life.
Mark Devlin is senior technical manager at Prudential