Helen O’Hagan, Technical Manager at Prudential, looks into the planning strategies that can deliver considerable tax savings for your clients.
Inheritance tax (IHT)
Consider Margaret, featured on our Planning Matters family hub, who is a sprightly eighty year old with four children and several grandchildren. She’s recently been widowed and IHT planning is high on her agenda. IHT is increasingly a concern for clients – IHT receipts in 2015/16 were £4.7bn, an increase of 22% on the previous year. We’ve seen steady increases each year, but there are simple steps that can be taken to reduce a potential IHT liability.
- Annual £3,000 exemption
- Small gifts exemption (£250)
- Normal expenditure out of income
With the annual exemption, a client can give up to £3,000 in each tax year, either as a single gift or as several gifts adding up to that amount – the client can also carry forward any unused part of the £3,000 exemption, but if not used in that year, then the carried-over exemption expires.
Small gifts exemption
The small gifts exemption of £250 can be given to as many individuals as required. As long as the gift to each donee doesn’t exceed £250 the exemption applies. If, however, you gift even £1 over the limit, the whole exemption is lost in relation to that donee.
Normal expenditure out of income exemption
Consideration could also be given to starting a pattern of gifts that would qualify for exemption under the 'normal expenditure out of income exemption'. This is particularly valuable, given that the exemption has no monetary limit and instead applies where the taxpayer can show that a gift meets all three of the following conditions:
- It formed part of the client’s normal expenditure
- It was made out of income, and
- It left the client with enough income to maintain his/her normal standard of living.
Margaret has an excess of income and it makes sense for her to make regular payments into pensions for her family. Using the ‘normal expenditure out of income’ exemption means she’s immediately reducing her estate by the value of the gifts each year.
Previously, Margaret set up a discretionary loan trust as she was nervous about gifting large amounts of money. Any growth is therefore immediately out of her estate. Over time, Margaret can consider writing off chunks of her loan if she no longer requires access. These write-offs will constitute chargeable lifetime transfers (exempt if within the £3,000 annual exemption). This increases the amount available for the beneficiaries of her trust whilst reducing her estate.
For certain clients, gifting may also help keep estates below the £2m threshold in order that the residence nil rate band is not tapered on death. This subject is covered by Graeme Robb in his article in this issue of Oracle.
Gifting – lump-sum planning
If a gift is not exempt it will fall into one of two categories:
- Potentially exempt transfers (PETs) – these are often gifts of cash or transfers into an absolute trust.
- Chargeable lifetime transfers (CLTs) – these are normally gifts into discretionary trusts.
For those clients who wish to consider lump sum gifting, then the sooner the seven-year clock starts the better.
Clients with existing bonds might consider placing them into trust if personal access is no longer required. A bond is an efficient asset to place in trust as it doesn’t produce income, meaning there’s no need for an annual tax return. Bonds are generally segmented, which means the trustees can assign segments to discretionary beneficiaries (as long as they’re over age 18) who can subsequently encash at their own marginal rates of tax. Gifts into and out of trust do not trigger chargeable events for income tax purposes.
The transfer into trust will be either a PET or a CLT, depending on the type of trust used.
In David’s Planning Matters case study, he had an existing whole of life policy with a sum assured of £100,000, which had never been placed into trust. In that case, were he now to set up a discretionary trust, then a CLT would arise. The value is normally market value, which in David’s case was the surrender value of £28,000, given that he was in good health. There is, however, a special valuation rule (S167 IHTA 1984) that will apply, which means the value cannot be less than the total premiums paid (less any sums previously paid out). In this case, the total premiums paid are £40,000 and that will be the value that applies.
From April 2017, those who have been resident in the UK for more than 15 out of the past 20 tax years will be treated as deemed UK domiciled for all tax purposes. Their foreign and UK assets will be subject to IHT. Once an individual has become deemed UK-domiciled, they will need to leave the UK for six or more consecutive tax years to lose their deemed domicile status. (In practice, once the individual ceases to be UK tax resident, deemed tax domicile is likely only to be relevant for IHT purposes).
In Margaret’s Planning Matters case study, her daughter-in-law Carol has a Spanish domicile of origin but has been living in the UK for 14 years. She has monies in Spain and she should consider placing these funds into an excluded property trust before she becomes domiciled in the UK. This will mean that once she’s deemed domicile, those assets will remain excluded from UK IHT.
For any clients who have realised a chargeable event gain on an insurance bond in this tax year, then a personal pension contribution will have the effect of extending the basic rate band by the gross contribution. A contribution made in this same tax year could prevent a top sliced gain from breaching the higher or additional rate threshold. The Prudential tax relief modeller will calculate the benefits of this for specific situations.
For certain clients, the Enterprise Investment Scheme, Venture Capital Trusts and the Seed Enterprise Investment Scheme will be worthy of consideration. The respective tax reliefs are compared in an article in our Technical Centre.
Individual Savings Accounts (ISAs)
Our Technical Centre also contains an article on ISAs, exploring the different types and considering other aspects such as ISA transfers. In our Planning Matters family hub, John’s wife Anne has £18,000 in a cash ISA and perhaps she might wish to consider a transfer to a stocks and shares ISA to potentially generate an improved return? We also consider last minute subscriptions, which is always important in the context of tax year end planning.
There are three key elements in tax year end CGT planning:
- Realising losses
- Ensuring use of the annual exempt amount (AEA)
- Making negligible value claims (if it can be agreed with HMRC that shares are of negligible value, the loss arising is treated as a realised loss and is available for set-off against gains).
Gains realised by a client up to the annual exempt amount (AEA) are CGT free. The current AEA is £11,100. Use it or lose it!
If the client wishes to sell shares standing at a gain, and repurchase shortly afterwards, then remember the ‘bed and breakfast’ anti-avoidance rules, which match disposals against acquisitions on the same day and against acquisitions within the 30 days following the disposal. These rules are intended to deter those simply looking to realise a gain, and increase the base cost for future disposals (or those looking to realise an allowable loss).
The 'bed and breakfasting' anti-avoidance rules don’t apply in the following situations:
- Repurchase after 30 days
- Repurchase of non-identical shares/units
- Repurchase made by spouse
- Repurchase within an ISA or pension
A quick refresher on losses is also worthwhile. Clients are subject to CGT on total chargeable gains for the year of assessment reduced by:
- Allowable losses
- The AEA
The treatment of losses depends on whether they are losses of the same year or losses of earlier years of assessment.
Procedure for losses:
- Deduct any current year losses from current year gains – even if the net figure falls below the AEA. Any excess losses are then carried forward and set against gains which arise in the future.
- If the net figure above exceeds the AEA, and there are unused losses brought forward from a previous tax year then deduct those losses, but just enough to reduce the net gains to the AEA limit.
- If there are still unused losses from a previous year after they have reduced gains to the AEA, they can be carried forward to future years.
What does this mean from a planning perspective?
There is no point, from a tax perspective, in crystallising a loss when net gains in that same year of assessment are within the AEA.
Losses crystallised in a year of assessment in which there are no gains will allow the full amount to be carried forward.
If one spouse or civil partner has realised gains exceeding the AEA and the other spouse has uncrystallised losses, consider an exempt inter-spouse transfer followed by a disposal.
In our Planning Matters family hub, we have a married couple, John and Anne. In the case of John, he owned ‘income’ OEICs standing at a book gain of £40,000 and a rental property standing at a book loss of £30,000. John decided to encash these investments for planning purposes, meaning that the £30,000 loss was deducted from his £40,000 gain, giving rise to a net figure of £10,000, which is below his AEA of £11,100.
Simple planning strategies can deliver considerable tax savings for clients. It’s important not to overlook the basics, and not to put off year-end planning.
Take a look at the full range of case studies available on the Prudential Planning Matters hub.
Further support available on Prudential’s PruAdviser website: