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IHT: Time is money

One of my favourite references to use when discussing wealth management planning is the old Chinese proverb: ‘the best time to plant a tree was 20 years ago. The next best time is now’. However, it might be most appropriate to apply to inheritance tax (IHT) planning because of the importance time has on both allowances and reliefs, although it might be more apt to say that the best time to plant an IHT-efficient tree is seven years ago, but we will get to that.

IHT: Time is money
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  • Contributed by Glen Marshall
  • August 14, 2020
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There is an abundance of planning opportunities available to clients when considering IHT planning, which often results in the tax itself being referred to as a voluntary tax. I have summarised a client’s options below:

  1. Do nothing
  2. Spend it
  3. Lifetime gifts
  4. Will planning
  5. Life cover
  6. Trust planning
  7. Investments with tax benefits

I won’t go into too much detail on the individual planning points, but rather refer to the allowances and reliefs that underpin the planning and highlight the importance of preparing sooner rather than later.

Obviously, the strategy your client adopts will depend upon their motives and objectives. However, if they choose to do nothing because they believe it is their civic duty, or they ‘distrust their heirs more than they dislike the Inland Revenue’, as stated by Lord Jenkins in 1986, we will not know if this rings true without having approached the subject with them first. 

Income planning, especially in retirement, is pivotal to an individual’s strategy. Where we may have identified a potential IHT liability, adding an IHT consideration to this planning can be beneficial. For example, drawing income from a pension could be IHT inefficient because pension funds sit outside the estate for IHT purposes. It may be more efficient to draw from within the estate, from an ISA or savings account maybe. That being said, the drawing of income from an alternative source may seem insignificant in comparison to some situations, but the earlier you start the process the greater the potential IHT savings. For example, after five years of taking £5,000 a year from the IHT taxable estate to spend on non-goods relative services such as holidays etc, could reduce your IHT liability by £10,000, and £20,000 over 10 years and £30,000 over 15 years.

Most gifts from one individual to another are deemed as Potentially Exempt Transfers (PET), where the entirety of the gift is outside of the estate for IHT purposes after seven years. Where the value of this gift exceeds the Nil Rate Band (NRB), this could give rise to an IHT charge where death occurs within seven years of the gift. However, the IHT due would be subject to tapering relief, the rate of which is illustrated below.

 

Time between date of gift and date of donor's death

Taper relief

Effective rate on gift

3 to 4 years

20%

32%

4 to 5 years

40%

24%

5 to 6 years

60%

16%

6 to 7 years

80%

8%

With the above in mind, one can see the importance of time when making lifetime gifts. This could be even more important for larger estates where the incumbents want to make substantial gifts throughout their lifetime. 

It would be prudent to note that the current regime does allow individuals to make annual gifts of £3,000 per tax year, with the ability to utilise the previous year’s unused allowance. However, these allowances if left unused cannot be reclaimed at a later date. Therefore, they should be considered as part of an IHT-efficient strategy at the outset to ensure the allowances are not lost.

Wills are useful for ensuring the individual’s wishes are adhered to and the passing of assets are directed accordingly. We never know when the worst may happen. Therefore, this is something I encourage my clients to put in place as soon as possible. It can also be a conversation starter as it often highlights aims and objectives that have not been discussed before. 

Sometimes the simplest options are the best, and life cover, written into trust, is often the simplest method of addressing a client’s IHT position. It is can be particularly beneficial for clients with an illiquid estate or where they need to retain access and control of the estate. Addressing the client’s situation is vital to review each individual’s situation to assess affordability so the premiums can be maintained for the cover term; and where the premiums are paid out of surplus income, if structured correctly, this may mean the value paid for the premium could be immediately outside of the estate. Moreover, most life insurance is age sensitive, therefore, where a client is older, the premiums may be expensive. 

Trust planning can also be time sensitive because the transfer of assets into an absolute trust could be considered as a PET. Therefore, the seven-year clock will start ticking on this and would need to be considered. 

Access and control are key considerations when discussing trust planning. That is control over the assets and access to the capital and income associated with the assets to be transferred. One must consider the client’s needs and motives for engaging in such planning to ensure it is appropriate. This can often dictate the type of trust we use. For example, a Discounted Gift Trust (DGT) can provide an immediate reduction to the donor’s estate as well as a fixed income to the donor. However, will this income be too little or too much? The ‘income’ is actually a return of capital, thus, sees funds returned to the client’s estate which may potentially be subject to IHT if not spent. In addition to this, the rates of ‘income’ are indistinctly linked to the client’s age because they are based on mortality rates. Therefore, such planning may not be suitable for older clients. 

IHT-efficient investments can often be underpinned by Business Relief (BR), formerly Business Property Relief (BPR). Wherever we are investing in an AIM IHT ISA or another BR qualifying asset, for the most part, to qualify for the relief requires a two-year holding period which sees the value of the investment gain up to 100 per cent IHT exemption. 

Many individuals have accumulated substantial ISA savings over the years which could be transferred to an IHT-efficient ISA portfolio where the income tax and capital gains tax efficiencies can be retained in addition to added IHT benefits. This could see those savings that qualify for BR, IHT exempt after two years. Moreover, future utilisation of the annual ISA allowance could see further IHT savings be integrated into a client’s wider wealth management strategy.

It is commonly understood that the introduction of BR was aimed at preventing families from having to sell family businesses upon the death of the original owners to meet IHT liabilities. That being said, what do you do when the family business is sold during the individual’s lifetime? The sale proceeds could end up forming part of the client’s estate and lose the BR qualifying status. However, if the proceeds are rolled over into BR qualifying investments within three years of disposal, the IHT exempt status may be carried over without having to wait for a further two-year qualifying period.

To summarise, the earlier potential IHT liabilities are signposted the more options we have to save clients and their beneficiaries money and give them time to utilise annual allowances and associated reliefs. Including IHT in the conversation about their wider wealth management strategy can allow us to make even the smallest adjustments, which could have a big impact, and this is only emphasised by the availability of time.

Glen Marshall, wealth management consultant of Mattioli Woods plc. 

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