Estate assets are many and varied and include assets in the sole name of the deceased, jointly-owned assets, nominated assets and assets given away but where an interest is maintained.
They also include assets from which the client benefits but where they have elected not to pay the income tax charge, assets in trusts in which they have a right to benefit and the value of an alternatively secured pension fund.
Standard Life estate planning specialist Julie Hutchison says advisers have a big role to play in estate planning. “It is about adding value by giving holistic advice,” she says.
Many advisers will get involved only in the financial planning but they can also play a role in prompting clients to consider making a will or power of attorney.
Most important, a client needs to understand the negative effects of not acting.
Chiltern director of estate planning Nick Hughes says: “The danger is the client will bury their head in the sand and think they are immortal and not consider the tax or family issues.”
Paul Duckworth IFA chartered financial planner Paul Duckworth says without a will, a deceased client’s assets fall prey to the laws of intestacy. Instead of passing to the spouse in their entirety, assets will be spread between heirs. The spouse will receive the chattels, a legacy of 125,000 and a life interest in half the estate’s residue. The client’s children then receive the remaining half.
Writing a will is vital to ensure an inheritance goes to the right individual. Duckworth says: “You can control where the money goes.”
The main bulk of an adviser’s work on estate planning is in the mitigation of inheritance tax. IHT is payable when a person dies or when assets are transferred into a discretionary trust or to a company. If an estate is valued at under the nil-rate band, currently 300,000, no IHT is due upon death. As house prices have soared, however, more estates are now qualifying for the 40 per cent IHT rate.
In determining the best IHT mitigation strategy, Hughes says the adviser should consider the age, health and residency of the client, whether any of their assets qualify for tax relief and the tax status of their dependants.
The most simple measure is to transfer or gift assets so their estate falls below the 300,000 threshold.
Under new rules outlined in October’s pre-Budget report, spouses and civil partners can now transfer their nil-rate bands to each other so their maximum IHT-free allowance is fully used. This means a couple effectively have a combined nil-rate band of 600,000, increasing to 700,000 by 2010/11.
Gifts to individuals other than the client’s spouse or civil partner are free from IHT, provided the client lives for at least another seven years and does not benefit from the gifted assets. These are known as potentially-exempt transfers.
In every tax year, a client can make an annual exemption gift of 3,000 to a person or trust without the seven-year rule coming into effect. If the previous tax year’s exemption has not yet been used, it can be carried over to the present tax year. This means that a couple can effectively gift up to 12,000 in a single tax year.
Other tax-efficient ways of gifting include marriage gifts, small gifts, gifts from income, donations to political parties and charitable donations.
There are other effective ways of reducing the value of an estate. Hargreaves Lansdown head of financial practitioners Danny Cox says clients should consider putting their estate assets into a trust which separates the holding and control of assets from their beneficial ownership.
He says: “A trust is essentially a legal entity in its own right in the same way a company is. You are moving capital away from one ownership to another, reducing the value of your estate and so reducing the amount of IHT payable.”
One of the simplest and most effective ways to utilise this arrangement is to write a life insurance policy to trust. The policyholder is able to ensure the payout goes to the beneficiaries without delay. If the client does not write the policy to trust, he or she risks the sum adding considerably to the value of the estate.
Duckworth says: “If you put it into trust, then the policy is no longer in your estate. Death claims are paid to the trust, not the estate. The beneficiaries of the trust would probably be the same as those of the will but you have achieved a sum of money outside your estate without paying residual tax.
“Most life insurance companies reckon only 5 or 10 per cent of life insurance policies are in trust. It ought to be that just 5 or 10 per cent are not in trust.”
There are other types of trust that can help avoid IHT and ease the dispersal of assets after death, such as a loan trust or discounted gift trust. A loan trust involves the lending of asset where repayments can be taken from the loan at any time. A discounted gift trust is a tax-efficient way of gifting without giving away full access to the capital.
Cox says: “A discounted trust makes use of existing trust laws in a scheme whereby the client still has access to the capital and income. It is a loan so you can always have it back.”
Perhaps the most effective way of frustrating the taxman, however, is to make sure there is minimal inheritance left after death.
The adviser should help the client budget for all potential eventualities, ensuring they have enough income to live on, including the costs of care. After that is completed, what the client does with the rest is up to them.
A growing number of people are spending their children’s inheritance. A retirement spent going on Caribbean cruises and watching the sun set through the haze of rum cocktails at least has the advantage of knowing it is not the taxman who gets to decide what to do with your lifetime earnings.