Q: In previous articles we have looked at the types of trusts and the taxation of trusts. What can lead a client to want to consider using a trust perhaps in lifetime or on death?
A: The broad aim with lifetime planning is to reduce the estate such that it mitigates or eliminates inheritance tax (IHT) charges on the death of the individual.
Lifetime planning will involve carrying out a thorough fact-finding exercise. This will involve gaining as much information as possible, such as details of the assets owned by the individual, any lifetime gifts made and the family background. It is, of course, also important to know the details of the client’s will, that is, who their beneficiaries are and what their wishes are.
If a client is wealthy enough, they may want to make lifetime gifts of some of their assets, but they should be mindful of their own life expectancy and retaining sufficient funds for potential care costs. Once a lifetime gift is made, it cannot be taken back.
How much can a client afford to give away? The client should retain sufficient funds for the following possibilities:
• ill health
• divorce
• retirement
• death of spouse/partner
A client should not give away anything that they may want or need in the future. There are inheritance tax rules around ‘gifts with reservation’. Essentially, if an asset is given away – for example, an expensive painting – but your client keeps that painting hanging in their hallway, they have retained the benefit of the use of the painting. The painting has not actually been given away as we have reserved the right to continue enjoying it. Not only could the gifts with reservation rules apply but there are tax implications of pre-owned assets (which we will consider in a later article).
Whether a gift is made outright or into a trust can depend on a number of factors. Predominantly, the use of a trust could be where the client is wishing to make gifts, either in lifetime or on death, for the benefit of ‘minor’ children. Of course, the tax effects of the use of a trust are an important factor to bear in mind. Although your client may be wishing to save inheritance tax on his death, the tax cost of gifts made in lifetime can have significant impact. Income tax and capital gains tax (CGT) as well as inheritance tax should be reviewed.
Because of the interaction of taxes your client may have to accept, say, a small CGT liability in a larger overall IHT saving.
Lifetime planning should be reviewed on a regular basis, particularly if there is a change in personal and/or financial circumstances.
Ben Chaplin is managing director of Taxwise
