A client is aware that his family will be liable for a fairly substantial inheritance tax liability when he and his wife pass away. The client does not require access to all of the value of their estate. How can he achieve a solution whereby the amount of tax actually paid could be mitigated and ensure that his financial assets are held in a more efficient manner?
The client is married and aged 78. His wife is 76. Time is marching on for them as their health is not what it once was. Their total estate is presently worth in the region of £610,000, made up of property worth £200,000, with financial assets forming the balance. Some additional assets, in the form of insurance bonds, have been placed in trust over recent years.
The clients made wills a number of years ago in which they left their assets to each other or to their children if they passed away at the same time. This is a typical will structure that is suitable for the majority of people earlier in their lives but not so when there is a reasonable amount of wealth in the estate.
This situation is faced by many clients and, unfortunately, if the wills are not altered, will result in one nil-rate band being lost.
As a result, the value of the estate in excess of the nil-rate band will be £368,000, leaving an inheritance tax liability on their estate of £147,200 (40 per cent tax being payable).
The first action is to have their wills rewritten by a suitably experienced solicitor to make use of a discretionary will trust. Additionally, as part of this exercise, the solicitor ensures that they own their home as tenants in common rather than as joint tenants. Combined, this has the effect of enabling £242,000 to pass to their children free of inheritance tax on first death, giving an immediate inheritance tax saving of £96,800.
Although this action has a significant impact on the estate, it is only the first part of the solution as there still remains an inheritance tax liability of £50,400 (40 per cent of £126,000). Many advisers would at this stage suggest a whole-of-life, second-death plan placed in trust to provide the funds to pay the tax. However, this will not meet the client's objective of trying to ensure that as little of the tax as possible will actually be paid.
The simplest solution to this further liability might seem to be to gift the assets in excess of the combined nil-rate band to the children. Unfortunately, any such gift would have implications on the tax position of the children and would be classed as a potentially-exempt transfer. Under the Pet rules, there would be a liability to IHT during the seven years following the gift although the liability would reduce after three years.
The solution agreed upon is to use a discounted gift and loan scheme through an offshore trust. One of the best such schemes is offered by Canada Life International with its enhanced estate preservation account. The trust used is an interest-in-possession trust.
The Capital Taxes Office will allow an immediate discount for inheritance tax purposes so long as an income is taken from the account. The level of the discount depends on factors including the client's age, state of health and level of income to be taken. Normally, 5 per cent a year is the selected income (being a return of the original investment) and this is the case in this instance. This income must be taken for at least the seven years while the Pet rules apply.
The immediate discount achieved, based on an investment of £126,000, is £28,100, creating an immediate inheritance tax saving of £11,240. Even greater discounts can be achieved for younger and healthier clients.
All growth in the account falls outside the estate from day one. After three years, further savings are made, with the full value of the initial investment falling outside the estate after seven years.
The 5 per cent the couple receive annually from the enhanced estate preservation account can be used to gift £3,000 each to the beneficiaries, thus making use of the annual gifting allowance.