An example of combining a tax-efficient investment with a discretionary trust.
In this week’s Tax Angle, I’ve got a client scenario for you to chew over. Last week, I looked at the residence nil rate band (RNRB), which as of this tax year is worth £175,000 for an individual. This week, let’s look at how you might advise a client whose estate is above the £2 million RNRB taper threshold.
Julie is 81. She is widowed, with two children and four grandchildren. Her estate is worth a total of £2.8 million. Julie’s estate loses £1 of RNRB for every £2 by which it exceeds the taper threshold. If she were below the taper threshold, her total RNRB would be £350,000 (her own £175,000 allowance plus her late husband’s allowance which passed to her when he died). But as things stand, there would be no RNRB at all available to Julie’s estate.
Julie meets with her adviser to look at her estate planning options. As part of the discussion, they consider gifting as a way to reduce the value of the estate below the £2 million threshold. However, Julie is uncomfortable with the idea of giving away large sums, even though cash flow modelling suggests she can easily afford to and is highly unlikely to need all her assets during her lifetime.
What Julie’s adviser recommends instead
Julie’s reluctance to gift assets she could easily afford to is quite common. In December 2019, a survey commissioned by Octopus found that 89% of advisers surveyed said their clients have become more mindful, compared to five years ago, of potentially needing access to their money in later life. We hear the same thing anecdotally from many of the advisers we work with.
One way some advisers have responded is by recommending investments that qualify for Business Property Relief (BPR), which have grown in popularity over the last decade. A BPR-qualifying investment can be passed on free from inheritance tax once it’s been held for two years. The appeal for some clients is that the investment stays in their name, meaning they can sell it later on if they want to access the capital.
Before we go on, I want to draw your attention to two important points. The first is that there’s no free lunch here. BPR-qualifying investments put capital at risk. The value of any investment, and any income from it, can fall as well as rise, and investors may not get back the full amount they put in.
The second is that, while access to capital is an attractive benefit, it’s relatively rare for clients to draw down BPR-qualifying investments once they have made them. Making this type of investment can often help a client take the next step in estate planning, especially if they don’t want to use other strategies like gifting. Once they have, it’s common for a client to think of that investment as ‘belonging to’ their beneficiaries. It’s also much more efficient from an inheritance tax perspective to fund lifetime costs from other sources, which can help clients realise that they can in fact afford to gift some assets.