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Inheritance Tax (IHT) - Case study

Speed, Control, and Beating the Seven Year Rule

You may already know about inheritance tax (IHT), and you may be aware that most gifts are exempt after seven years. This is not however, a one size fits all solution. Many of our clients are not comfortable with the loss of control that making large gifts entails, or worry that if their circumstances or plans change, they may have permanently lost access to those assets. For others, a seven-year timeframe simply isn’t realistic in terms of managing their estate.

At a recent review with our client Tim, we learned of changes in his circumstances which required an accelerated approach to his inheritance tax planning.

Tax 2

Overview

Tim is aged 88 and recently lost his long-term partner. His financial plan did not account for this, and the change left him with no direct descendants, or transferrable inheritance tax allowances.

Tim’s main assets are:

  • Guaranteed income of £14,000 each year which does not currently cover his expenditure
  • His home which is valued at £650,000
  • Accrued cash valued at £300,000
  • Inheritance tax inefficient investments valued at £480,000

Tim’s current inheritance tax position:

  • Estate valued at £1,430,000
  • Inheritance Tax Nil Rate Band of £325,000
  • Taxable estate of £1,105,000
  • Inheritance tax at 40% = **£442,000**

Tim wished to remain in his home for the remainder of his life, and anticipates that he needs in the region of £29,000 annual income. This represents a current shortfall of £15,000 each year. He is not frail, but acknowledged that at age 88, utilising the seven-year gifting rule to place his inheritance tax inefficient investments outside of his estate represented a risk he was not comfortable with. This is because if Tim passes away within 7 years, some or all of the assets he gave away would be clawed back into his estate and charged with IHT.

Deal

Introducing Business Relief Investments

Business Relief products are a specialist type of investment which can be purchased by private investors. Investments that qualify can be passed on completely free from Inheritance Tax as long as they have been held for at least two years, and are still held upon death. This is to say that as long as the funds are not likely to be required by the investor, the seven-year rule can be reduced to just two years through the use of these investments.

These investments do not pay any income, however they are invested in listed and unlisted smaller companies, so there is potential for the investment to increase in value over the long term. As the companies are small, there is inherent risk of loss, and high-quality business relief investments typically invest in a wide range of these small companies in order to mitigate this risk somewhat. Nonetheless, these are high risk investments, and it is very important to discuss your risk tolerance and the appropriateness of such an investment with an adviser.

Under specific circumstances, an element of life insurance is available which would pay the majority of any IHT bill after just 6 months. This serves to provide peace of mind during the two-year window required for the investment to become entirely exempt from IHT.

How This Helped Tim

Following a full financial plan for Tim, we recommended that he invest the full £480,000 balance of his IHT inefficient investment into a new Business Relief investment. In two years’ time, this will leave Tim’s IHT position as follows:

  • Tim’s Future inheritance tax position:
  • Estate valued at £950,000 (home + cash)
  • Inheritance Tax Nil Rate Band of £325,000
  • Taxable estate of £625,000
  • Inheritance tax at 40% = £250,000
  • Saving of £192,000 versus current position after 2 years
Collaboration

Tax Efficiency

Business Relief products can significantly decrease your eventual IHT bill

Collaboration

Speed

Business Relief investments are exempt from IHT after 2 years if they continue to be held upon death

Collaboration

Access & Control

You maintain control of the investments until passing, meaning you can access the funds if needed

Collaboration

Diversification

Business Relief investments can complement other parts of your financial plan e.g. pension planning

Collaboration

Succession

You maintain control over who will eventually receive the Business Relief assets

Introducing Discounted Gift Trusts

A Discounted Gift Trust (DGT) is a trust-based inheritance tax planning arrangement for those individuals who wish to undertake inheritance tax planning but who are unable to lose full access to their investment. In the case of Tim, he wanted to generate £15,000 additional income each year, whilst ensuring that the capital element of the investment gains an inheritance tax advantage.

A DGT enables Tim to invest and ‘give away’ the £300,000 cash he has accrued, but still benefit from the income that investment generates (up to 5% of the amount invested each year). The seven-year clock begins ticking on the gift, however it also benefits from an immediate IHT discount based roughly upon the donor’s life expectancy and the amount of income being taken. The exact discount calculation is complicated, and you should speak to one of our expert advisors to get a better idea of possible discounts available. The invested funds are not available to the beneficiary until the settlor has passed away.

How This Helped Tim

In this case, Tim is able to invest and ‘give away’ £300,000 and obtain an immediate discount on the gift for IHT purposes. Assuming that he survives 7 years, there will be no further IHT to pay on the gift, however if he passes before that date, the discount applies. He is also able to begin withdrawing 5% of the investment each year, which gives him the £15,000 he requires to cover his living expenses.

Meeting

Could This Be Right For You?

At The Penny Group, financial planning is an entirely bespoke process, and no two client plans will be the same. We have access to a wide range of financial planning solutions, and it is only after we have built a thorough understanding of your circumstances, plans, and goals, that we can recommend a route forward which is right for you.

We are trusted by clients across the country and at all stages of life. So if you would like a stronger say in your financial future, please do get in touch for an initial consultation.

Written by Freddie Sallis,
Protection Adviser & Trainee Financial Planner

The client name and financial figures in this case study have been changed to make the calculations easier to follow.

Get in touch

Email info@thepennygroup.co.uk or call 0207 061 2345 if you have any questions or should you wish to speak to one of our advisers.