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Financial planning case study: Relief route to retirement

The problem: The clients are a married couple aged 64 and 65 looking to reduce inheritance tax and minimise capital gains tax. They have a good income and plenty of assets. They own two homes with only a small outstanding mortgage. The husband’s pension is worth around £300,000 and there is an Isa portfolio worth around £50,000.

They have £200,000 in cash on deposit, held in fixed term deposit accounts. The client earns about £85,000 a year but is likely to go into semi-retirement this year, which will cut his earned income in half. They receive £2,900 a month in pension and cash income with outgoings of £2,000.

They want to help their children without affecting their standard of living. They would also like to gift lots of assets but protect from divorce, etc. There is also an issue of long-term care and death benefits.

Issues to take account of:
● Should they be reviewing and increasing their pension provision?
● Should they consider using a loan trust?
● Are they in a position to make gifts using normal expenditure out of income relief?

The solution
First, I would recommend a reasonably significant contribution into the client’s pension plan, perhaps up to the maximum for this tax year of £50,000. The client is able to maximise their retirement fund while getting tax relief. The client will also receive, in the medium term, a tax-efficient home for his investment in terms of inheritance tax and capital gains tax.

The pension would be payable on his death into a spousal bypass trust, meaning his assets can remain sheltered from inheritance tax, rather than loading up the estate of his wife.

He has also potentially secured an improved income for later life and go a significant distance towards not having to rely on sale of assets to fund potential long-term care costs. That does not really solve the entire problems of inheritance tax or of being able to help their children right now. I would recommend a strategy of engagement with HMRC to justify and agree with them that normal expenditure out of income relief should apply.

This relief is available where clients adapt a pattern of continuous gifting out of their normal income. It does not automatically apply and it is safest when HMRC have agreed this pattern in principal. It is not essential but I prefer to see HMRC engaged.

My clients could adapt a pattern of gifting to their children/grandchildren which could be significantly in excess of all other annual allowances. We need to ensure there is sufficient income to ensure standard of living is not eroded, nor are they resorting to withdrawals of capital to maintain the continuous gifting.

Finally, I would be inclined to recommend the use of a loan to a trust or a combination of a gift and a loan into trust.

In essence, the trust is established to which you then instil a loan agreement. The trustees receive your loan which is then invested into an appropriately taxed investment vehicle. The loan is interest-free but is repayable on demand under a binding legal obligation, giving you access to your original loan capital.

Any growth on the investment is held outside your estate for the benefit of the trust beneficiaries. The outstanding loan will remain as an asset of your estate and potentially be subject to inheritance tax on your death. As the settlor is excluded from benefiting from the investment growth, the IHT liability is effectively frozen at the investment amount at its current value.

The potential for IHT on the outstanding loan can be reduced where the loan is repaid in instalments and then spent. As long as the loan repayments are not accumulated elsewhere in the estate, the taxable asset (the loan) will gradually reduce in value, as will the resultant inheritance tax liability.

The trustees could fund loan repayments by taking withdrawals from the investment which can be preset at outset, or can be made ad hoc.

Ian Hudson is principal of Hudson Green & Associates


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