Jonathan Simmons: Thinking outside the IHT box

In Stellar AM's last article Tina Stone explained the basics of IHT and touched on how HMRC collected an eye-watering £5.4bn in 2018/19 for a voluntary tax that can be legitimately mitigated. Here, Jonathan Simmons looks at the solutions…

As a financial adviser, having a solid foundation plan is key to saving your clients’ families from losing thousands of pounds in unnecessary tax. Doing nothing will result in a flat 40% tax on all assets over the nil-rate band (NRB) and residence nil-rate band (RNRB).

An IHT liability does not take into account the levels of income or capital gains tax your clients have already paid throughout their life. Thankfully, there are plenty of IHT reduction solutions available. But what solutions are most suitable for your clients?

Firstly, make sure your client has written their will otherwise their assets will not be distributed in accordance with their wishes, but to individuals set out according to the rules of intestacy.

Not having a will can incur several delays in settling their estate and can be known to cause huge amounts of stress on the surviving partner and other family members. Not forgetting the liability to IHT means that HMRC is likely to become the biggest beneficiary.

Traditional solution 1

A seemingly simple way of reducing the value of your clients’ estate is to arrange for them gift it to others. Each person has a £3,000 annual gift exemption that allows the gift to be immediately exempt from IHT. Any further gifts above this amount in the same tax year may be subject to IHT should you die within seven years of making that gift.

This option is slower than other solutions and, what is more, there exists a myriad of rules governing exactly who can you gift to and how much they can receive per tax year. For example, a couple can gift up to £5,000 to each of their offspring, but only £2,500 to each other or to their grandchildren.

Smaller gifts of £250 per person are allowed, provided they are not too regular and not already receiving a larger gift. This is not the most suitable system for power of attorneys who will have to document each lifetime gift upon death or else these may still form part of your client’s estate for IHT purposes.

However, the little-used gifting excess income can provide greater flexibility. In all gift situations, it is imperative to maintain accurate records to back up the decisions taken. Moreover, any gifts that do become chargeable to IHT will use your clients’ nil rate band first. This means that the gifts themselves will not be subject to tax but will have an effect on the remainder of their estate.

Traditional Solution 2 – Should you place all your trust in trusts?

Trusts are a good way to leave assets to children or grandchildren because you can set conditions around when and how the money or other assets can be accessed and used (such as when they go to university).

Although trusts allow your client to give custody of their assets to the people they want to benefit most from their estate, the client is forgoing access to some or all of the original capital and, along with that, any future growth.

Trusts work by progressively transferring assets out of the client’s estate. Certain trusts can generate ‘income’ in the form of withdrawals. However, it is important to make sure the trust is established and will not be confused as a ‘gift with reservation’. These benefits enjoyed by your client during their lifetime – such as gifting property and living in it rent-free – can still be categorised as part of the estate.

Gifting and trust planning both cause the donor to lose control over their capital to other members of their family. If this is a big consideration, then there is an alternative.

Alternatives to the traditional

An increasingly popular way of reducing a client’s IHT liability is by investing in assets which qualify for business relief (BR). Unlike traditional IHT solutions, BR does not remove the control of the money from the estate and also offers plenty of flexibility to the client.

Shares in qualifying businesses attract 100% BR – provided they have been held for at least two years at the time of death – after which they are fully relieved from any IHT liability, providing they are held at the time of death.

What is more, the two year BR ‘clock’ begins the moment your client’s capital in the trading businesses are purchased. The trading company will use the funds to undertake selected projects to generate the targeted returns.

Advisers need to be wary about selecting the right BR investments that successful mitigate the risk of inflation and eroding capital. With enough diversification, this risk is spread across a number of assets in a range of different industries that are uncorrelated – meaning a loss in value in one industry won’t have a knock-on effect on the others.

Which clients are suitable for BR?

With the distinct advantages of speed, ownership and an income stream to support your clients’ lifestyle – BR assets are a real plus for clients whose financial circumstances are likely to change as they grow older and require long-term care.

Flexibility is the hallmark of BR solutions and they can be adopted to fit many client circumstances. For those families with assets over the nil rate band to former and current business owners – BR provides the opportunity to tailor needs to a diversified lower risk asset-backed portfolio.

Lastly, those with clients who are married or in a civil partnership wanting to leave the asset to their spouse, it is worth highlighting to them that only one needs to survive the two year BR ‘clock’ – even if made in a single name.

Jonathan Simmons is senior marketing associate at Stellar Asset Management