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£600,000 Inheritance Saving - Case Study

Background

A new client approached us as she had been widowed (unfortunately more than two years ago) and her husband had always dealt with the finances.

Mrs Client was well provided for, with more income (pensions, dividends and interest) than she needed and the following assets (approximate values):

 

The Family House (mortgage free) £500,000
Farmland   £250,000
Cash Savings                                             £100,000
Stocks and Shares inc. ISAs     £1,350,000
AIM Portfolio                                            £400,000
VCTs   £100,000
  £2,700,000

 

She wanted to ensure that she would not run out of money, but also that the family would not pay inheritance unnecessarily.

Lifetime Cashflow Planning

Because the client’s first concern was not to run out of money, we undertook a detailed Cashflow analysis of her income, expenditure and assets.

We were able to confirm and reassure her that that she had more than sufficient income and capital – and then went on to model the inheritance tax planning measures we were considering, to ensure that they didn’t jeopardise her financial security.

Inheritance Tax Liability

Despite having undertaken some inheritance tax (IHT) planning previously, the client’s current liability is still roughly £843,000, with an additional £12,000 payable by her grandchildren (because of gifts made to them in 2014).

The IHT creates two key problems, firstly the actual charge – that the client’s family would lose just over £850,000 in tax on her death.

Secondly, there are the practicalities of actually paying the tax. Bizarrely, the executors cannot normally use the assets of the estate to pay the tax. Consequently the executors might have to use their own resources or borrow from the bank to pay the IHT before the estate can be settled and the estate distributed.

The client had already taken some steps to address the second problem with some life assurance under trust for her children. These assets, in particular the £250,000 life assurance, would be available to the children to help pay the IHT.

Whole of Life Assurance Recommended

With the current IHT liability of c.£855,000 it would be sensible for the client to insure the amount, so solving the two problems identified above.

As she had £250,000 of existing life assurance the advice to the client was to arrange an additional £600,000 of cover.

Rather than arranging this on a single premium basis, we recommended arranging it on a regular premium basis (which was £2,700 a month, subject to underwriting).

By writing the life assurance under trust, and because the client had income in excess of her current spending, it is likely that the entire proceeds of £600,000 could pass to the children tax free – i.e. the premiums would be exempt under the Normal Expenditure Out of Regular Income exemption. This would enable the children to pay the inheritance tax on the estate.

Business Property Relief – ISAs to AIM Recommendation

Given the recent change to allow ISAs to hold AIM shares, the advice to the client was that whilst this would increase the risk significantly, it would also have the advantage that after two years the value of the portfolio would be exempt from IHT.

As the client’s ISA portfolio was valued at £157,791 this would give a potential IHT saving of £63,116 after two years.

Holdover Relief Trust Recommendation

The bulk of the client’s non-exempt assets are tied up in either her home, or her share portfolio.

We explained to the client that it was not effective for inheritance tax to gift her home and continue living there rent free. Whilst it would be possible to gift the Share portfolio, it would create a problem in terms of capital gains tax (CGT) as the gift would be considered as a disposal.  Given the gains on the portfolio this would create an immediate and undesirable tax liability.

Fortunately there is an option whereby the client can gift capital for the benefit of her children and grandchildren and avoid incurring CGT.

By establishing a Discretionary Trust for the benefit of her children and grandchildren and transferring holdings from the share portfolio, she can claim “holdover relief” which simply pushes the liability onto the trustees.

The creation of a discretionary trust during lifetime is a chargeable lifetime transfer for IHT purposes – and taking into account the client’s previous gift history we calculated she could transfer up to £295,000 into the Discretionary Trust.  This would effectively put £295,000 on the seven year clock for inheritance tax purposes, a potential IHT saving of £118,000 after seven years.

In the normal way, the client herself cannot benefit from the trust – and as a non ‘settlor interested’ trust, holdover relief could be claimed and a CGT bill could be avoided.  (Any minor children or spouses as beneficiaries would also make it settlor interested, but that isn’t the case for our client).  

Given the other trusts created by the client, the Trustees would have an annual exemption of £1,100 to utilise against any gains, with their tax rate currently standing at 28%. However, the trustees could also make use of holdover relief again in the future when distributing capital from the investments to the children and grandchildren. The beneficiaries could then utilise their own CGT annual exemptions to minimise, or even avoid completely the tax on any distributions made.

We identified that holding the share portfolio would utilise the £295,000 available Nil Rate Band, and allow the transfer over £100,000 of unrealised capital gains to the trust.

Although the income tax treatment within the Discretionary Trust has some minor drawbacks, the potential IHT and CGT savings considerably outweigh these.

After seven years the exercise could in effect be repeated when then the seven year clock has expired.

Conclusion

The combination of the three strategies (Life Assurance, ISAs to AIM and Holdover Relief Trust) when combined, were projected to give the following savings to the client and her family.

Tax and Estate Planning Chart

The declining red bar for the Life Assurance is due to the monthly premiums eroding the benefit to the client, however this is offset by the AIM shares (within the ISAs) becoming exempt after two years and the Holdover Relief Trust monies being exempt after seven years.

In addition, the above chart shows the impact of growth on the AIM shares and the Holdover Trust being outside the client’s estate.

Note, this case study was based on Rowley Turton's understanding of HMRC rules at the time, and is an example of our work only. This case study is not individual advice, and you should obtain individual professional advice based on your own personal circumstances, and the current rules, before undertaking any action. Rowley Turton accept no liability for anyone taking any action as a result of this case study or any other information on our website.

 

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