How to tackle the ongoing issue of IHT

It is a subject that can and does crop up throughout the year, and it is something that has been providing HM Treasury with a decent source of revenue. 

According to figures from Moneywise, over the year to the end of February 2018, IHT receipts rose 13 per cent year on year, hitting a £5.3bn high and prompting a review of IHT to be ordered in January this year.

While it is something that is not necessary to leave to the last minute each tax year end, there are reasons, such as irregular cash flow or bonus season, why some people may have to leave it until March before considering IHT planning.

And there is plenty to consider, as Rachael Griffin, tax and financial planning expert at Old Mutual Wealth, comments: "The IHT system is not straightfoward and has a number of legacy clauses and exemptions that the government could seek to reform.

The complexity of IHT planning will often depend on the complexity of a client's personal and financial circumstances. Tracyann Kneen

"To help clients mitigate IHT, it is important to ensure they understand their allowances and point out some options they have today, that will avoid a big bill later."

Moreover, as Tracyann Kneen, product technical manager at Nucleus avers: "The complexity of IHT planning will often depend on the complexity of a client's personal and financial circumstances."

But Richard Hoskins, co-founder of Kin Capital, believes IHT planning has actually become less complicated, although he admits it is "still a challenging area for advisers".

Mr Hoskins explains: "Trusts, offshore planning and other aggressive approaches are less available than they were, so despite enhancements to allowances around an individual's principal private residence, the options have narrowed."

RNRB

From April 2017, the government did start making it fairer on those individuals left behind and facing punitive death duties as a result of rising property prices and an IHT threshold of £325,000, which has been in place since 2009.

The government phased in the residence nil-rate band (RNRB), which will allow married couples or civil partners to have an eventual extra £325,000 worth of IHT-free allowance per couple. This is expected to be fully phased in by 2020 to 2021.

Although the government website provides some helpful case studies to explain how the RNRB will work, Tim Morris, IFA for Russell & Co says: "Awareness of this is not great. This was the £1m threshold long-promised by the government and, once again, the way this has been delivered adds an unnecessary layer of complexity."

So there are some measures to make it fairer and less punishing - but there is still the need to mitigate IHT and to factor this into yearly tax planning. 

As James Nield, investment manager at Thesis Asset Management comments, there are "three broad options for those seeking to mitigate IHT". He summarises these as:

• Spend your wealth.
• Give it away.
• Pay tax on it.

"For as long as we have IHT, these courses of action will remain relevant", he says, although he welcomes the various changes in legislation, allowances and limits, which have enabled some "differing approaches to develop".

He continues: "One of the major drawbacks of options one and two are that once the money has gone, it has gone. For many clients this is a difficult hurdle to overcome, as they fear that in later life they may end up needing it."

Given the rising cost of long-term care, this is an understandable concern for many people. 

Gifting

Writing something into gifts and trusts is a popular way of passing on wealth while the client is still alive.

While this can be done any time of the year, some elements of gifting, such as exempted gifts, are often left towards the end of the tax year, when clients may have a clearer idea of their financial situation. Yet as Mr Morris says: "Many people do not even use their annual exemptions.

"Investing in a bond held in trust is fairly straightforward but I find this tends to be more popular with older clients who have money to spare that they will not need any access to."

With exempted gifts, a client can give away £3,000 worth of gifts each tax year (6 April to 5 April) without them being added to the value of your estate. Clients can also carry any unused annual exemption forward to the next year - but only for one year.

Yet, as Ms Griffin asserts, it is also the job of the financial adviser to make sure the person "stays within certain rules - for instance, it must not have a negative impact on their standard of living."

According to the tax man, each tax year, a person can also give away:

• Wedding or civil ceremony gifts of up to £1,000 per person (£2,500 for a grandchild or great-grandchild, £5,000 for a child).
• Normal gifts out of your income, for example Christmas or birthday presents - you must be able to maintain your standard of living after making the gift.
• Payments to help with another person’s living costs, such as an elderly relative or a child under 18.
• Gifts to charities and political parties.

There is a seven-year rule, however, which means your clients have to be certain they have a lot of years left in them, or there will be tax to pay.

A 40 per cent IHT charge will be levied on gifts given in the three years before death, while gifts made three to seven years before your death are taxed on a sliding scale known as ‘taper relief’.

Source: Gov.UK

The seven-year rule applies to trusts as well as to gifts.

For example, bare trusts are often used in estate planning. A bare trust is where the assets in a trust are held in the name of a trustee but go directly to the beneficiary, who has a right to both the assets and income of the trust.

Transfers into a bare trust may also be exempt from IHT, again as long as the person making the transfer survives for seven years after making the transfer.

The HM Revenue & Customs website has a helpful checklist of the various types of gifting and trust, which is worth referencing.

But according to some, by the time most people come to think about gifting or writing money into trust, it is probably too late. 

According to Mr Hoskins: "Unfortunately the best advice for a donor will always be to gift the assets during their lifetime. However, in the absence of a financial adviser, IHT planning only normally starts to be a concern for individuals when they are well within the seven years for a gift to fall outside of their estate.

"While it's the best approach, involving minimal fees or investment risk, it often creates a new anxiety that the beneficiary or a spouse of the beneficiary will blow the money."

Business relief

Mr Nield says that a "middle ground" to solve the potential problem of spending it or saving it 'just in case' could be investing in Alternative Investment Market (Aim) shares or other assets which qualify for business relief.

Business relief - previously known as business property relief - allows some assets to be passed on free of tax or with a reduced bill.

He comments: "In brief, this is a way of investing money, retaining control over it, but shortening the length of time the donor must wait before the assets concerned are outside their estate."

To benefit from what Mr Hoskins calls one of the "most under-used forms of IHT planning", one has to have invested in qualifying investments, ie investments that are not listed on a main stock exchange, and have invested in those companies for at least two years. 

Mr Nield adds: "Typically, investors in assets qualifying for this relief will see the value of these investments fall outside their estate after two years, compared with seven years for an outright gift of cash, for example."

According to the Gov.UK website, you can get 100 per cent business relief on:

• A business or interest in a business.
• Shares in an unlisted company.

You can get 50 per cent business relief on:

• Shares controlling more than 50 per cent of the voting rights in a listed company.
• Land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled.
• Land, buildings or machinery used in the business and held in a trust that it has the right to benefit from.

You can only get relief if the deceased owned the business or asset for at least two years before they died.

"EIS investment provides 100 per cent exemption from IHT because of BR, so can be used as part of an IHT mitigation strategy," says Mark Brownridge, director general of the EIS Association.

"BR reduces the value of a business or its assets when working out how much IHT has to be paid. The powerful combination of tax relief, potential investment returns and IHT exemption does make them excellent tax-planning tools."

Case Study: Using EIS to reduce IHT (Source: EIS Association)

As an example, a widow has an estate valued at £1m. Her late husband left the whole of his estate to her, keeping intact his entire tax free allowance of £325,000 which passed on to her.

Her tax-free allowance increased to £650,000 as a result. There is therefore a 40 per cent tax liability on the assets of her estate above £650,000 on death.

This is a significant tax bill of £140,000 and will reduce the value of the estate being passed to her loved ones.

By investing into an EIS investment with shares that qualify for business property relief, she can potentially reduce that IHT bill, providing that the shares have been held for a minimum of two years and she still holds the shares on death.

A £100,000 investment into an EIS would reduce the taxable value of her estate by £100,000.

Only £250,000 would therefore be liable, reducing the IHT bill by £40,000.

Last thoughts

The issue of IHT planning is not going to go away. Jack Rose, head of tax products for LightTower Partners, explains: "On the one hand, there is obviously the relatively new RNRB and other legislative changes to pensions and Isas, for example, which has widened the potential spectrum of solutions for clients to be as IHT efficient as possible.

"This obviously adds complexity to the advice process. At the same time, people are typically living longer and the potential IHT solutions need to take that into account as well. 

"If that were not enough, there are also the considerations of future generations that often need to be addressed at the same time. It's part of the reason that IHT solutions using BR have grown in popularity so much in recent years.

BR reduces the value of a business or its assets when working out how much IHT has to be paid. Mark Brownridge

"The flexibility and control they offer investors can be very attractive and an important component to any potential solution."

Ultimately, as Nucleus' Ms Kneen comments: "The best way to mitigate IHT is to be thinking about it as early as possible. 

"Getting a client to think about their own mortality is not always an easy conversation, but highlighting how much the taxman will take if tax planning is not carried out can sometimes help to focus a client's mind."

simoney.kyriakou@ft.com