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Beating the IHT challenge

Taxation There are a number of different ways to lower IHT bills while avoiding the Poat, says Simon Hildrey

Mitigating inheritance tax has become more challenging since the Government introduced the pre-owned assets tax on April 6, 2005. But planning schemes do still exist which can reduce IHT bills and are not caught by the Poat.

The latest addition is an Isle of Man-based fund, property wealth manager, which has been launched by Close Brothers and Equity Release Services. This has been designed to mitigate IHT on the home through the use of equity release and single-premium whole of life policies.

Equity Release Services chief executive Ged Hosty says an investor first takes out a home reversion plan. The investor’s home is transferred at its current market value to the plan. In return, the investor receives a lease back of the property, so they can continue to live in the house until death, and a cash lump sum.

The cash lump sum is then invested in a single premium bond written by Isle of Man Assurance on the investor’s life. This bond will then invest into the property wealth manager fund, which holds the properties of all investors using the product.

By giving units in property wealth manager to children, grandchildren and other beneficiaries, Hosty says the investor makes a potentially exempt transfer. This means if the investor lives for another seven years, there will be no IHT to pay on these units and the amount of tax declines over these seven years. Hosty adds that Revenue & Customs has confirmed that this product is not caught by Poat.

Other products used to mitigate IHT are offered by insurance companies. Arguably, these products are more actively marketed by offshore rather than onshore insurers. Insurance plans to mitigate IHT can be based onshore but insurers say bigger cases are written through offshore policies.

The main difference between onshore and offshore insurance schemes for mitigating IHT is the tax treatment of the funds within the policy, says Smith & Williamson director of financial planning Paul Garwood.

He says: “Offshore bonds used for IHT planning have tax deferral benefits that are not available through onshore bonds. Income, with the exception of dividends, and capital gains are not taxed until the bond is wholly or partially cashed in.

“Gross roll-up can enhance returns within the bond and tax deferral can be used in planning for investors who may fall within a lower tax band in the future.” On encashment, gains, as with onshore bonds, are subject to income tax rather than CGT.

Garwood says another attraction of offshore bonds is the greater investment choice they offer. He says investors should check the number of lives which can be insured by onshore IHT plans. “It is important that more than just the husband and wife’s lives are insured by the policy that a settlor is taking out. There does need to be a reason for other lives to be insured, however.”

Scottish Equitable International technical manager Margaret Jago says that if the bond will be written for a long time, it may be beneficial to use offshore schemes. This is because of the compounding effect of the gross roll-up of the underlying funds.

Jago says that while IHT plans can be based onshore or offshore, the discounted gift scheme tends to be more widely offered by offshore insurers than their onshore counterparts.

There are four main types of IHT schemes offered by offshore insurers. These are the gift trust, the discounted gift scheme, the gift and loan trust and the retained interest trust. Jago notes: “The gift trust is for wealthier investors who can afford to give away part of their assets. The assets placed into the trust are a PET as they leave the settlor’s trust and therefore are free of IHT after seven years. But the settlor does not have access to capital within this trust.”

She adds that the discounted gift scheme is where an investor places assets into a trust and receives a set percentage a year as income. Typically, this will be 5 per cent a year as this is the maximum withdrawal before income tax is levied. If the settlor lives for more than seven years, the assets in the trust are not subject to IHT.

Skandia head of tax and financial planning Colin Jelley says discounted gift trusts are the most popular at the moment because of many people’s need to continue to receive an income while mitigating IHT.

He says another way of achieving this is to use a gift and loan trust. In this case, assets are placed in trust and an annual income is paid which can be varied over time.

But the loan does not leave the settlor’s estate so any loan outstanding on the investor’s death will be subject to IHT. But Jelley adds that the growth on the capital in the trust is deemed to be outside the estate. “If 500,000 is in the trust and it grows by 100,000, then IHT will not be levied on the 100,000 growth.”

Another option, says Jelley, is to establish a retained interest trust either onshore or offshore. “If an investor wants access to half of their assets, they can set up two offshore bonds, split the capital between them and write them in trust. But this approach limits the amount of money the settlor can withdraw as income every year without triggering a tax charge.

For example, if the settlor has 100,000 then 50,000 could go into each bond. This means he could only receive 2,500 a year as income. But under a retained interest trust, one bond is used and 50 per cent of the capital is given away.

“This means that the 5 per cent withdrawal is based on the whole amount invested even though it is still only taken from the settlor’s share of the bond. Thus, instead of receiving 2,500 a year with no immediate tax liability, it would be 5,000 under the retained interest trust.”

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