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A brief guide to

INHERITANCE TAX PLANNING AND THE INVESTMENT OPPORTUNITIES

Why do you need tax planning?

A good number of us can build up quite large amounts of savings throughout our lives. Much of this can be our own pension plans, which we and our employers pay into each and every month. As our total savings, combined with other tangible assets, increase, so do the tax implications. The tax system in the UK is complicated and it can be difficult to understand how it affects you. It’s far from obvious how to take advantage of the various tax allowances, reliefs and opportunities on offer.

 

Good tax planning can help you organise everything, so you don’t pay any more tax than you need to, as well as managing your overall financial plan to help avoid significant tax bills later in life. This guide will show you what you need to consider and provide information on the opportunities available to you and your family.

INHERITANCE TAX

The number of individuals caught out by Inheritance Tax (IHT) is at an all-time high. In 2018/19 alone, HM Revenue & Customs (HMRC) received £5.4bn. The reason for continual year on year growth lies mainly in the fact that property price inflation outstrips tax reliefs and exemptions available to investors. The current nil rate band (NRB) of £325,000 has not changed since 2009 and the current annual exemption of £3,000 available to individuals hasn’t changed since 1981. 

How to calculate whether an estate is subject to Inheritance Tax

This is relatively easy. All you need to do is add up all the assets you own and then subtract the total liabilities that you owe. Anything you are left with is subject to IHT at 40%.

MAIN EXEMPTIONS

Of course, there are a good number of exemptions that you can take advantage of. The main ones are as follows:

1

Marital Status

Transfers made between spouses or civil partners made both during life and on death are exempt from IHT. It’s also worth noting that a surviving spouse can inherit their partner’s NRB. This means surviving partners have an allowance of £650,000.

2

Main Residence Nil-Rate Band (RNRB)

As we’ve already said, property price inflation is one of the key reasons that IHT is now applicable to more people than ever. To help counter this, the Government introduced a RNRB in 2017 which promises to provide married couples and civil partners an inheritance tax-free allowance of £1m when combined with their existing NRB. Whilst it’s a very useful addition, there are some caveats:

  • Those who downsize (or sell outright) after July 2015 retain the RNRB to the full value of the original property assuming assets of an equivalent value will be transferred.

  • The allowance is tapered away for estates with a value of over £2m, on a 2:1 basis.

  • The allowance is only available to individuals who are passing their estate to direct descendants, therefore individuals with no children cannot benefit from the relief.

3

Annual Exemption

Individuals may make transfers exempt for IHT up to £3,000 in any one tax year with the ability to carry forward the previous year’s allowance for one year if not already utilised.

4

Small Gift

Individuals may gift up to £250 to any number of parties (other than an individual in receipt of the annual exemption already mentioned) in any one year.

5

Normal Expenditure

An all too often overlooked exemption. This area of planning is quite complex but, generally, if a transfer is part of a donor’s normal expenditure (and is made out of income and doesn’t affect their usual living standard) it will be exempt from IHT. Detailed guidance should be sort in relation to this.

6

Wedding Gifts

For those getting married or entering into a civil partnership, individuals can gift the following:

  • £5,000 if the donor is a parent to either party

  • £2,500 is the donor is a grandparent or made from the bride or groom to the prospective spouse

  • £1,000 is the donor is any other person

7

Business Relief (BR)

Introduced in 1976, BR is a tax relief provided by the UK Government as an incentive to increase investment in certain types of trading businesses. BR is available on businesses, on an interest in a business or a partnership, on unquoted shares and on land, buildings and plant and machinery when utilised in a qualifying trading business.

8

Agricultural Property Relief (APR)

Similar to BR, some agricultural property can be passed on free from IHT either during the owner’s lifetime or as part of their will. It should be noted that the qualification criteria is complex and detailed tax advice should be sought. But it can provide relief of 50% or 100% depending on the type of property.

Computer Keyboard

THE THREE MOST IMPORTANT PARTS OF IHT PLANNING

1. Reliefs

2. Gifting and Potentially Exempt Transfers (PETs)

3. Trusts

1. Reliefs

As we’ve already shown, there are several reliefs available to investors offering up to 100% relief from IHT, effectively making the transaction entirely exempt. 

2. Gifting and Potentially Exempt Transfers (PETs)

We covered some of the gifting rules already, but investors should be aware that gifts to individuals and trusts are subject to PET rules. This means that they receive taper relief and the amount of IHT reduces over time until, after seven years, there is no charge. And taper relief is only available where the value of the gift or gifts exceeds the Nil-Rate Band.

Here's how it works in terms of the reduction you can receive for the years between the date of the gift and death:

3-4 years

4-5 years

5-6 years

6-7 years

7+ years

20%

40%

60%

80%

100%

Gifts with reservation

As well as keeping an eye on PET charges, settlors need to be mindful of making a “gift with reservation” if transferring assets. This means gifting an asset whilst retaining a benefit from it. Common examples include gifting:

  • Property, whilst continuing to live in it

  • Tangible assets (paintings, cars, antiques) whilst still retaining them

  • Money whilst still receiving the interest

A gift with reservation is not considered a gift for the purposes of IHT and will therefore be treated as part of the donor’s estate when calculating inheritance tax.

The Settlor

The individual gifting the asserts into trust

The Beneficiaries

The individuals receiving the income and/or capital

Life Tenants

Beneficiaries entitled to the income generated

Remaindermen

Beneficiaries entitled to the capital

Trustees

Any individual or individuals responsible for administering the trust  and carrying out the wishes of the settlor.

A long-established route to potentially mitigating IHT. Before we look at the most common types of trusts, it’s worth being familiar with the key parties involved in their creation:

3. Trusts

TYPES OF TRUSTS

Bare Trusts

These are generally considered the simplest form of trust with beneficiaries receiving an automatic and immediate right to both the capital and interest accrued, typically on the death of the settlor or at the age of 18.

 

Discretionary Trusts

No beneficiary has an absolute right to income or assets from the trust. Typically, the trust will define a class or classes of beneficiary (e.g. “direct descendants”) allowing assets to be distributed over multiple generations. Contributions to Discretionary Trusts are Chargeable Lifetime Transfers for IHT purposes.

 

Chargeable Lifetime Transfers (CLT)

A CLT is a transfer that is neither exempt nor potentially exempt and is therefore immediately chargeable. The most common CLT is when an individual settles assets into a discretionary trust. Contributions to a discretionary trust that exceed the available NRB will suffer a 20% CLT charge. Where the settlor dies within seven years of creating the trust, a further 20% IHT may be payable.

 

Interest in Possession (IIP) Trusts

An IIP or IPDI (Immediate Post-Death Interest) trust will have two types of beneficiary, a Life Tenant who is entitled to the income generated by investment assets and the Remaindermen who are entitled to the assets of the trust on the death of the Life Tenant. Trust assets should be invested to balance the interests of these two parties. Trust assets are considered part of the Life Tenant’s estate for IHT purposes and can often lead to an unexpected tax bill.

 

Loan Trust

As the name suggests, a settlor does not gift their assets away with a loan trust which differs from the vast majority of others described. This means there is an element of control as the settlor can recall their loan if they require access to the capital. Whilst this may sound an ideal solution due to the “gift with reservation” rule referenced previously the capital will never actually leave the settlor’s estate. Only the growth on trust assets will fall outside of the estate for IHT purposes.

 

Discounted Gift Trust (DGT)

A DGT offers investors an income (that must be determined at outset) for life and an immediate reduction in the value of the settlement for IHT purposes. The balance of the settlement is considered a PET for IHT purposes, meaning the settlor must survive seven years before the assets will be IHT exempt.

 

The size of the reduction available will be determined by the level of income drawn and the settlor’s life expectancy, with larger reductions available to settlors with a long life expectancy who also draw a high income. Where the income generated remains unspent, it will form part of the estate for IHT purposes.

Couple in Nature

CASE STUDY

A married couple have a taxable estate of £2.7m. Currently they have a combined Nil-Rate Band of £650,000 but no RNRB as it has tapered down to zero. This leaves them with a £820,000 IHT bill.

 

So, they invest £700,000 into a BR qualifying asset. They then wait two years before gifting assets to a beneficiary or settle into a trust.

The estate value is then £2m after 7 years of a death. The RNRB reclaims savings of £140,000 in IHT as well as saving £280,000 on BR assets.

This reduces the IHT bill by £420,000, to £400,000 in total.

INVESTMENT OPPORTUNITIES

Let’s look at two of the key investment opportunities available to individuals.

1. Alternative Investment Market (AIM) Based ISAs

2. Enterprise Investment Schemes

AIM Based ISAs

While Individual Savings Accounts (ISAs) offer valuable benefits during an investor’s lifetime, some people are not aware that ISAs are subject to inheritance tax like most other investments. 

 

Most investors value the tax-free growth and income provided by their ISAs, but many are not aware of the inheritance tax their families will have to pay on these investments when they die. The first £325,000 of an individual’s estate is currently inheritance tax free, but everything over this could be taxed at 40%. This could be of concern for investors who have accumulated large sums in ISAs over the years. 

 

An AIM Inheritance Tax ISA could be a solution for ISA investors facing this problem. It aims to eliminate inheritance tax on their investment after just two years, in return for taking the risk of investing in smaller companies. And the investment will stay within the ISA wrapper, with all the tax advantages that an ISA provides. 

 

The best way to understand this, is to use a case study.

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MEET DAVID, A COMMITTED ISA INVESTOR

He has never married, and as his house alone is worth more than £500,000, he expects that his daughter Emma will have to pay 40% inheritance tax on his investments when he dies. This includes the ISA investments he’s been building up over the years. He’d like to find a way to invest that retains the tax benefits of an ISA wrapper, without the inheritance tax liabilities. 

 

Peter talks to us and we make an assessment based on his objectives and attitude to risk. We then suggest investing in an AIM Inheritance Tax ISA. It comes with the same tax benefits his ISAs have always enjoyed but, after two years, the ISA becomes free from inheritance tax, assuming it is still held at the time of death. It also offers access to the growth potential of carefully selected UK smaller companies. 

 

The AIM Inheritance Tax ISA invests David’s money in a selection of companies listed on AIM (the Alternative Investment Market). Certain AIM-listed companies qualify for Business Property Relief (BPR).  BPR has become increasingly popular with some investors interested in reducing the inheritance tax liabilities potentially due on their estate, who are also comfortable with higher risk investments. After holding AIM Inheritance Tax ISA for two years, the investment should become free from inheritance tax. 

Enterprise Investment Schemes

A tax-efficient investment that was introduced by the UK Government in 1994, The Enterprise Investment Scheme (EIS) incentivises investment into smaller UK companies. Investors are incentivised with relief on Income Tax, Capital Gains Tax and Inheritance Tax.

High Growth Potential

Many companies seeking EIS funding are aiming for significant growth.

 

Reliefs compensate some of the risks

EIS offers investors tax reliefs, including loss relief if the investment in a company fails.

 

Investing in the future

EIS-qualifying companies are typically young, innovative companies who tend to be good at finding new solutions to everyday problems.

 

Diversifying investment portfolios

EIS offers an extra layer of diversification for investors who are comfortable with the risks.

 

Complements other long-term investments

EIS shares are a long-term investment, with a unique set of benefits and risks. They complement other long-term investments but should not be considered as a complete replacement for them.

 

Tax planning opportunities

There are a range of tax reliefs available with EIS, providing opportunities. You can find out more about these below.

TYPES OF EIS

Single Investment Company SEIS

Here, you invest directly into one business and this is typically used by investment professionals. It’s generally used to back companies in which the investor has a lot of confidence.

 

EIS Portfolio

As the name suggests, you invest in a range of qualifying companies. These companies will typically be larger than those in a SEIS.

 

Seed EIS

This means investing into a smaller business than a standard EIS. The good news is that additional reliefs are available as a result of the extra risk of investing in a small business.

Headline Reliefs for EIS Investment

As smaller businesses bring benefits to the UK economy, HM Treasury offers a range of tax advantages. It should be noted that you must hold the investment for a minimum of three years to take advantage of the tax reliefs. They are:

Income Tax Relief

30% Income Tax Relief on the amount invested, that can be claimed against the teas year of the investment and/or the previous year.

 

Tax-free Growth

Growth is exempt from Capital Gains Tax.

 

Loss Relief

Loss relief may be available at your marginal rate of tax.

 

Inheritance Tax Relief

EIS shares qualify for Business Relief so the investment is exempt from IHT so long as it is held for 2 years at the time of your death.

 

Capital Gains Tax Deferral

Capital Gains can be deferred from 3 years prior and 1 year post investment.

  • Tax rules are subject to change

  • If you sell your shares early you will lose the tax relief

  • Your capital is at risk; you may not get all of it back and you may lose all of it

  • Investing in small companies is inherently risky; they may not perform well or may fail completely

  • EIS investments should be considered as longer-term investments and may be more difficult to realise than securities listed on the stock exchange

THE RISKS OF EIS

At Financial Framework Wealth & Estate Planning we can provide a wealth of advice and solutions when it comes to investments and tax planning opportunities within. If you’d like to find out more or discuss any of the topics we have covered, then please do get in touch.

IN CONCLUSION

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Financial Framework Wealth & Estate Planning Ltd is authorised and regulated by the Financial Conduct Authority. The Financial Conduct Authority does not regulate will writing, taxation and trust advice. Not all Inheritance Tax Planning solutions are regulated by the Financial Conduct Authority. We are entered on the Financial Services Register No. 843450 at https://register.fca.org.uk. Registered office: 35 Westgate, Huddersfield, HD1 1PA. Registered in England No. 11602026. The guidance and/or advice contained within the website is subject to the UK regulatory regime and is therefore primarily targeted at customers in the UK.

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