Paragon Independent Financial Solutions Ltd is an appointed representative of Sesame Ltd which is authorised and regulated by the Financial Services Authority. Sesame is entered on the FSA register www.fsa.gov.uk/register/ under reference 150427.
The FSA do not regulate some forms of mortgage and Inheritance Tax Planning.
Lifetime Planning
Lifetime planning involves giving assets away to your intended beneficiaries.
Each individual has an annual exemption of £3000, which can be given away, totally free of IHT, regardless of how long the donor lives.
There is no limit to the amount that can be given away, though there may be inheritance tax implications.
Three ways of giving are:
Direct Gifts
These are simple gifts, with 'no strings attached', where the donor gives up control of the asset and access to any of the benefits that it could provide.
The Inland Revenue regards this type of gift as a 'Potentially Exempt Transfer' ('PET'), which will be completely out of the donor's estate, if he survives for 7 years from the date of the gift.
Gifts where the donor can still benefit are regarded as remaining in his estate, regardless of the fact that legal ownership has been changed. This legislation was set out in the 'Gift with Reservation' (GWR) provisions, which came into force in 1986. Examples of benefits would include living in a property, without paying a market value rent, and receiving an income from an asset. and effect. In 2004, the government acted aggressively against some 'contrived arrangements' which took advantage of loopholes in the GWR legislation. It introduced the 'Pre-Owned Asset Tax' (POAT) legislation, which imposed an income tax charge on many 'contrived' arrangements not caught by GWR rules.
Gifts into Trust
Parents may be reluctant to give away a large sum of money to their children, without retaining any control over how the gift is used. This is one area where trusts can prove useful.
A trust may sound complex, but this is not necessarily the case. For example, some IHT mitigation arrangements use financial services products, which incorporate trusts, utilising standard documents, provided by the life insurance company. Essentially, a trust allows someone to make a gift, but still retain control over it. The person making the gift (the settlor) is usually a trustee and chooses who he would like as additional trustees. This means that the settlor could, effectively, continue to manage which assets a trust fund invested in.
Many trusts allow the trustees to change the beneficiaries, or their shares in the trust assets (flexible trusts), although it is also possible to use a 'bare' trust, which does not offer this flexibility. Recent (2006) changes in legislation have led to a difference in the inheritance tax treatment, when establishing bare and flexible trusts. There are also different rules for pre-existing trusts and new trusts, with flexible trusts becoming subject to the same IHT regime as discretionary trusts (which do not need a current beneficiary to be specified). While the principles of IHT planning remain relatively simple, the detail has become even more complex, making this one area of financial planning where expert advice is vital.
For IHT purposes, a gift into a flexible trust is now regarded as a 'chargeable transfer'. This means that, where the value of the gift (added to any chargeable transfers made in the previous 7 years) exceeds the nil rate band, the amount above that level will attract an immediate 20% IHT charge. This treatment does not apply to a gift into a bare trust, which receives the same IHT treatment as a direct gift.
For a flexible trust to be effective from an IHT viewpoint, the settlor cannot be a beneficiary and therefore loses access to the trust assets.
Gifts into IHT planning trusts
Parents, considering whether to make gifts to their children, to reduce IHT, have to make sure that they will have enough capital and income for themselves, in future.
If you, as a parent, knew that you could continue to benefit from arrangements that you moved into IHT planning arrangements, you may be more relaxed about allocating more to them. In theory, legislation prevents this. However, in practice, there are legal arrangements which make this possible. Three examples are given.
Loan Trusts (sometimes called Gift and Loan Trusts) allow you to move any future investment growth out of your estate, while retaining access to your capital.
Find out more 1.
These are generally accepted as the most effective tool for lifetime planning, for those who are prepared to give away capital, provided that they can, effectively, retain an income from that capital.
Find out more 2
Certain investments are subject to 'Business Property Relief'. This means that, after 2 years, they are outside of the taxable estate, for IHT purposes, although the owner retains full access.
Find out more 3
This type of trust is ideal if you want the security of having access to your money, whenever you need it, but you are happy to forego any growth or income produced.
You make a loan to the trust, which is then invested. The loan is repayable on demand. As the original capital used to make the loan remains accessible, it stays in your estate. However, any investment growth achieved is moved outside of the estate.
One common arrangement is to take regular loan repayments of 5% per annum (this avoids any income tax), to supplement your other income. Although the immediate effect of this arrangement is negligible, in terms of IHT savings, the cumulative effect, over a number of years, can result in a significant reduction in your taxable estate. Indeed, the compound effect of the growth can exceed the value of the original loan.
Back to where I was
This is about as close as you can get to having your cake and eating it, in IHT terms! For those in good health, it offers a guaranteed IHT saving, regardless of how long they live.
You give away capital to a trust, where the beneficiaries are usually your children. You agree to take a fixed level of regular withdrawals from the trust, to supplement other income. These withdrawals will continue until you die, at which point, any remaining funds pass to your beneficiaries. You can continue to control the funds and change the ultimate beneficiaries, but cannot have access to any of the capital, other than the regular withdrawals. It is possible for a married couple to establish a Discounted Gift Trust, so that the withdrawals continue, at the same level, until the second of them dies.
The IHT treatment is:
The value of a proportion of the original investment ('The Discount') is moved out of the estate immediately.
The remainder of the investment ('The Gift') is moved out of the estate after 7 years.
The split between these two components depends on the life expectancy of the settlor and the level of withdrawals to be taken. The discount is directly related to these factors.
At first sight, this appears to be too good to be true. You are making an IHT saving, yet still receiving benefit. Not only that; your estate will save IHT, even if you do not survive 7 years. The reason for this apparently generous IHT treatment is that the Inland Revenue treats the two components of the trust in different ways:
Discounted Gift Trusts achieve the following:
AIM portfolios offer an excellent balance of tax-efficiency and control for clients who are prepared to allocate a proportion of their assets to more adventurous investments.
Shares in qualifying unquoted companies are regarded as business assets, and because of this, they benefit from a preferential tax regime. This includes shares of companies which are traded on the Alternative Investment Market (AIM). These companies are usually smaller and / or younger than those traded on the main stock exchange and the shares can be 'less liquid' when an investor wishes to sell them. For these reasons, they should be regarded as relatively high risk investments. Nevertheless, many of the shares will have the potential for significant, tax-efficient growth.
Because Business Property Relief applies, these shares are free from IHT, once they have been held for 2 years, even though you retain full access and ownership. Should you wish to dispose of them, for example, because they have made a significant gain, Business Asset Taper Relief will apply. This means that, after 2 years, only 25% of the gain will be chargeable, effectively reducing the Capital Gains Tax rate to 10%, for a Higher Rate taxpayer.
The effective risk of this sort of investment can be significantly reduced by holding a professionally managed portfolio of AIM shares.
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