Martha and Jonathan are a married couple both aged 64. They have two daughters. Judy is aged 35, married and has two young children. Her sister, Sarah, is single with a 10-year-old son.
Martha and Jonathan are still working, their home is unencumbered and they have prudently saved for many years. Although they have never considered themselves particularly wealthy, their combined estate is in the region of £1m. In short, they enjoy a comfortable lifestyle.
Although they regularly meet with their financial adviser, inheritance tax planning has never been a priority – until now that is. Martha’s mother died six months ago and she inherited £310,000. She is aware that her and Jonathan are now in the IHT ‘bracket’ and has asked their financial adviser for help.
Prior to meeting their adviser, Martha had a plan in mind of retaining £100,000, giving each daughter £75,000, and each grandchild £20,000. Martha has had a strained relationship with Sarah who has led a troubled life but nevertheless she would like her to benefit along with Judy, albeit that she has concerns that Sarah might simply blow the money.
The adviser informs Martha that the £100,000 retained will remain within her estate and the intended gifts will be potentially exempt transfers, subject to the seven-year rule.
In other words, exempt if she survives for seven years but if she dies within seven years, then the gifts would fall back into her IHT calculation with no possibility of taper relief given that they are within the nil-rate band.
The adviser also draws Martha’s attention to the inflexibility of these outright gifts, including no future access to the funds gifted, no possibility of changing her mind retrospectively, full access by the grandchildren as soon as they become adults and no flexibility to cater for future grandchildren.
The adviser explains to Martha that a key component missing in her strategy is control and with an alternative strategy, it is possible to retain control and do so in a more tax efficient manner. Martha is intrigued to learn more.
The adviser suggests that Martha executes a deed of variation for the full £310,000.
She would not be varying her mother’s will as such but instead redirecting her inheritance, which would be treated for IHT purposes as if it has been carried out by her mother.
Although Martha’s estate will fall by £310,000, provided the necessary conditions are satisfied, then it will be treated for IHT purposes as if the redirection had been made by her mother. In other words, the redirection is not a gift by Martha and she is not therefore making a gift subject to the seven-year rule.
The deed of variation must be made within two years of the date of death but Martha is well within that timeframe. The adviser recommends that she “varies away” her inheritance into a discretionary trust to provide her with the control which would have been absent with outright gifts.
For IHT purposes, her mother is considered to be the settlor, meaning that Martha can be a potential beneficiary of the trust without infringing gift with reservation rules. Martha will be both a trustee and a beneficiary giving her full control.
Her adviser recommends she asks a solicitor to deal with the necessary paperwork and draft the discretionary trust.
The adviser offers her the contact details of a local solicitor.
Once the trust has been established, Martha and Jonathan – who are the trustees – seek investment advice from the adviser.
The record keeping and self-assessment obligations arising from income-producing investments seem a bit complicated to Martha and Jonathan. The adviser, however, draws their attention to a fund that is available in a non-income producing insurance bond “wrapper”, which offers the prospect of low volatility with stable returns. This is appealing to them as they are looking for a “peace of mind” investment. The adviser explains to them that there will be no tax return obligations unless and until a chargeable event gain occurs.
The insurance bond provides the trustees with access to 5 per cent tax- deferred withdrawals and enables them in the future to gift segments to their chosen beneficiaries (children and adult grandchildren) to access their personal tax position upon a subsequent encashment.
The revised strategy provides control, tax-efficiency and simplicity. In due course, Martha and Jonathan enjoy their role as trustees distributing funds to current and future beneficiaries as and when required and they even treat themselves occasionally.
Graeme Robb is technical manager at Prudential