Another way to use trusts in estate planning

Here’s a scenario that may be familiar.

A client harbours worries about what might happen if their children’s marriage ends in divorce. In particular, what might happen to any assets they leave to their son or daughter.

This can be an issue when it comes to estate planning. Settling assets into trust is one option, and can ensure the money will benefit grandchildren even if their parents divorce. But it comes at a cost. Anything settled into trust above the nil-rate band would incur an immediate chargeable lifetime transfer of 20%.

Not only that, but if the client were to die within seven years of setting up the trust, further inheritance tax would also be payable.

Fortunately, there is an alternative.

Another way to use trusts as part of a client’s estate planning

Geraldine has two children and four grandchildren. She’s keen to make sure those grandchildren all get to benefit from her wealth. She’s concerned about the implications if she leaves money to her son or daughter. What if her son spends it all on himself? What if one of the children gets divorced after they’ve received their inheritance?

Geraldine has not yet done any estate planning. She meets with her financial adviser and explains her objective – to leave a legacy for her grandchildren – and also her concerns.

Geraldine’s adviser, Keith, explains that because she has not previously made any gifts or set up any trusts, she can put the first £325,000 (the nil-rate band) into trust with no charge. Geraldine is relieved to hear this, and likes the idea of a trust because it helps her manage who will benefit from her money.

That said, she has an existing share portfolio worth over £800,000, and wonders if it’s possible to put more than the £325,000 into trust.

Keith explains that it is, but that anything above that amount would be subject to a chargeable lifetime transfer. In other words, if she wanted to settle the entire £800,000 into trust, the amount available to Geraldine’s grandchildren would be reduced by £95,000.

Keith goes on to explain that there is another option. Geraldine could transition some or all of her share portfolio into shares in one or more companies expected to qualify for Business Property Relief (BPR). 

Geraldine is unfamiliar with BPR. Keith explains that it’s an inheritance tax relief offered by the government that incentivises investment into businesses that meet certain qualifying criteria. It’s only available on the shares of unquoted or AIM listed companies. BPR-qualifying investments are considered high-risk (see below), so advisers will need to ensure their clients are comfortable with the additional risks being taken to meet the estate planning objective.

Keith goes on to explain how the planning would work. Geraldine would sell some or all of her share portfolio, and reinvest the proceeds into a BPR-qualifying investment. Once she has held the BPR-qualifying shares for two years they should be zero-rated for inheritance tax. This means Geraldine can then transfer the shares into a discretionary trust without it triggering a chargeable lifetime transfer charge.

So long as the BPR-qualifying shares stay in the trust for seven years, or until Geraldine passes away (whichever is sooner), they should not create an inheritance tax bill for Geraldine’s estate.

In addition, if Geraldine’s estate is above the taper threshold for the residence nil-rate band (currently £2 million), settling some of her wealth into trust during her lifetime could restore the full value of this relief to her estate when she dies.

What are the risks?

As mentioned, shares in companies expected to qualify for BPR are high risk investments. They put capital at risk, meaning the value of an investment and any income from it could go down as well as up. Investors could get back less than they invest. 

Investors also need to understand that the value of inheritance tax relief will depend on an investor’s personal tax situation, and on tax legislation that could change in future. Tax relief depends on portfolio companies maintaining their qualifying status.

In addition, AIM-listed and unquoted shares can fall or rise in value more than shares listed on the main market of the London Stock Exchange. They can also be harder to sell. 

TOMORROW: Tune in to the Octopus Online Show

Every month, the Octopus Online Show explores a different advice topic. Tomorrow’s episode (10am, Friday 31 July) looks at how you can help your clients overcome their fears at times of uncertainty, so they can take advantage of opportunities presented by the crisis.

It promises to be an informative 45 minutes, and you’ll get CPD for attending. For more information, click here.

BPR-qualifying investments are not suitable for everyone. Any recommendation should be based on a holistic review of your client's financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: July 2020. CAM009992.