Guest blog by Brian Radbone, Technical Counsel at Transact
Since 2006 we have seen a rise in the number of households now liable to inheritance tax increase by around 2.5 times while the amount of inheritance tax paid has increased by about 3 times over the same period. £5.7bn was collected in the first three quarters of the 2023/24 tax year and seems to set to increase as thresholds and allowances remain fixed.
There have been recommendations issued in recent years about attempting to simplify the inheritance tax regime, but its complexity does allow for specialised planning to help reduce the potential tax burden whilst also ensuring wealth is transferred as intended. Furthermore, there is a ‘toolbox’ of available planning aids to help do this.
Transferring wealth during your lifetime
Exemptions
Exempt gifts between spouses/civil partners are unlimited while £3,000 can be gifted to anyone each tax year (plus any unused allowance from the previous year) plus £250 to as many different people as you like and opportunities for further exempt gifting are possible in connection with weddings. Beyond this it is then possible to gift as much as you like ‘out of normal expenditure’ on an exempt basis provided there is a recorded intention to do this on an ongoing basis, funds are transferred from after tax surplus income and you do not adversely affect your standard of living.
Outright gifts
Any amount of gifts can be made on a ‘potentially exempt’ basis (PET) and will fall out of the estate after seven years. Where passed to children and grandchildren the funds can be tax sheltered in JISAs, LISAs or ISAs as well as pensions, up to the relevant subscription allowance limits, or into bare trusts where the recipients’ tax allowances can typically be used.
Failure to survive seven years from the date of a gift means it will become a chargeable transfer and may become liable to IHT depending on the amount of nil rate band available, if any.
Whilst effective from an IHT mitigation perspective if you survive seven years, such gifts mean a loss of control which may not be acceptable when looking at how the transferred wealth may end up being used – there may be a need for more involved planning.
Gifts with control
Discretionary trusts provide an ideal solution for gifting with control – the transferred wealth is controlled by the trustees (normally including the donor during their lifetime) who will be advised by the donor when and to whom to distribute benefits. No IHT is charged on establishment provided chargeable gifts of this type do not exceed the donor’s nil rate band (NRB – currently £325,000) over a seven-year period. IHT may also be payable at 6% of any excess trust value over the trust’s NRB (currently £325,000 less any other chargeable transfers made in the seven years before this trust was established) at a ten year anniversary. There may also be an IHT charge on any capital distribution where there was a charge at the previous ten-year anniversary or on establishment for withdrawals in the first ten years.
The IHT position can be complicated further if the donor were to die within seven years of making a PET. This will impact on the NRB available on any discretionary trust established after the failed PET, or on the NRB available to any discretionary trust established after the date of the failed PET, leading to a possible unintended IHT charge.
The increase in control offered by a discretionary trust does come at a price. The trustees are liable for any income and capital gains tax and the highest applicable rates although no tax will be due where income is £500 or below in a tax year. If an investment bond is held in the trust, however, the tax liability can be passed to the recipient beneficiary by assigning individual policies so that any gain arising on surrender will be their income tax liability.
Larger transfers of wealth
Family investment companies (FICs) enable an unlimited amount to be given away in the same way as PETs but this time enabling donors to keep control. The control is established through the articles of association and shareholder agreement with a board of directors, typically including the donor(s), ensuring the company is run in accordance with these. Different share classes determine how income and capital are dealt with as well as where voting rights are held and there will be protections put in place to deal with lifetime incidents, such as divorce, to ensure the intended inheritance is not threatened.
FICs are typically set up with the donor(s) making a loan which is used to establish the shares which are then gifted to the intended beneficiaries. The donors can recall all or part of the loan if required or may choose to gift it in the future in which case it will be a further PET at that time.
FICs can be established using existing assets but there may be capital gains tax (and other taxes depending on the asset type) due as a result of the change of ownership.
Transferring wealth following death
Investing in certain higher risk investments can also provide efficient inheritance planning for those with the appropriate risk profile and who wish to benefit from holding the investment whilst still alive rather than giving it away. Unquoted shares and those quoted on the Alternative Investment Market (AIM) will acquire Business Relief and be transferred free of IHT following death provided they were held for at least two years.
There is also using the will to facilitate the passing on of wealth as intended – for example by including a trust and so ensuring it goes to intended recipients at the right time. Should the beneficiaries agree to a different way of distributing this wealth then they can use a deed of variation to do this provided this happens within two years of death.
Summary
So despite the increase in the IHT burden, quality inheritance planning can mean that the only losers will end up being HMRC (less tax) and disappointed non recipients (those who would inadvertently benefit if there was no planning in place) while clients, advisers and platforms all win.
If you’d like to hear more from Brian and the Transact team, other events you can attend are detailed here:
Adviser-Events – Transact
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