For professional advisers only Thesis Asset Management IHT and Tax Wrappers Andy Zanelli FPFS, ACMI, Chartered Financial Planner Senior Technical Consultant This presentation is directed at Professional Financial Advisers only. It should not be distributed or relied upon by retail clients. 1
Stats, stats and more stats.. IHT receipts were around 4.9 billion in 2016-17, an increase of 4% compared to 2015-16. It was 22% in 2015-16 and 12% year on year growth observed from 2013-14 to 2014-15. Receipts data for the 2016-17 tax year is based on payments received by HMRC. Other data relating to the composition of estates, the use of reliefs and the tax due on estates is provided for estates passing on death in 2014-15.. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/340426/ihtnationalstatisticscommentarydocument.pdf
IHT receipts 2001-02 to 2016-17 IHT receipts in 2016/17 were 4.9 billion; 4% higher than 2015/16. This is the highest amount since the current IHT system was introduced in March 1986. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/340426/ihtnationalstatisticscommentarydocument.pdf
Number of estates for which tax is due by estate band 2007/8 2014/15 While the numbers of estates liable to tax has increased overall since 2007-08.
IHT liabilities by region 2010/11 2014/15
IHT - A Brief History of the Standard Nil Rate Band NRB first set to 325,000 from 6 April 2009. NRB set at current level of 325,000 by Finance Act 2010 for 2010/11 to 2014/15 Finance Act 2012 linked automatic increases for the NRB to CPI (previous year to September with result rounded up to the nearest thousand) This was to apply from 6 April 2015 However, legislation allows for automatic indexation to be overridden for a tax year if the Government sets a different figure! Finance Act 2014 froze the NRB at 325,000 until 5 April 2018 Finance (no2) Act 2015 now freezes it at 325,000 until 5 April 2021
IHT Planning options Inheritance Tax Planning the options NO Is Income or capital available? Income Capital NO Do you need income? YES Do you need Access? Do you need Access? NO YES YES NO Get someone else to pay! Whole of Life Plan subject to a suitable Trust Outright gift under Trust Asset left subject to discretionary will trust Loan Trust Flexible Reversionary Trust Discounted gift trust
ISA tax efficient? Client has a number of investments including 50,000 invested in a cash ISA. The current rate of interest on the ISA account is 3%. They have no need for the capital and currently live comfortably on their pension income. They are very keen to save tax wherever possible and this is one of the main reasons why they like the ISA investment How tax efficient is the ISA?
ISA on death The ISA fund has grown to 67,196* by the time of death in the tax year 2027/28. This includes tax free growth of 17,196 over the 10 years until death. In reality, how tax efficient has the ISA been? It s not efficient at all in the event of death!! * 50,000 growing at 3% p.a. for 10 years
ISA IHT position Inheritance Shrinking Account Assuming that the house uses up any available nil rate band all of the remaining assets will be subject to IHT at 40%! The ISA account has grown tax free by 17,196 over the 10 years until death. 50,000 ISA fund (no withdrawals) Term Value* IHT @ 40% 10 67,196 26,878 All of the tax free growth generated over 10 years plus 9,682 of the original capital has been for the benefit of HMRC!! * 50,000 growing at 3% p.a. for 10 years
Back in 2017.. Client decides to invest the ISA fund in an investment bond, subject to trust, for their children. The bond is invested in a cash fund which, after charges, returns an average of 2% p.a. net of charges over the 10 years until death. After 7 years the investment is outside of the estate for inheritance tax purposes. 50,000 Bond investment (no withdrawals) Term Value* IHT @ 40% 10 60,950 0 If the client is a basic rate taxpayer in the tax year of death or the bond is assigned to a non higher rate taxpaying beneficiary then no tax will arise on the surrender of the bond * 50,000 investment growing by a hypothetical 2% p.a. net over 10 years
Forward to 2027 The ultimate value of tax free growth.. ISA net return in 10 years after IHT Bond value in 10 years free of IHT 40,318 60,950 Even though the ISA grew over 10 years by 50% p.a. more than the bond the net return to the beneficiaries was 20,632 less!!
Forward to 2027 The ultimate value of tax free growth.. What would the cash ISA have had to grow by p.a. to give the beneficiaries a similar net return as the bond investment produced? 7.35% p.a. net!! (5.35% p.a. more than the bond!) 50,000 ISA fund (no withdrawals) Term Value* IHT @ 40% Net return 10 101,623 40,649 60,974 * 50,000 growing at 7.35% p.a. net for 10 years
Loan trust Outside Estate, assumes 5% growth Amount of loan repaid 100,000 Outstanding loan 25,000 50,000 75,000 100,000 25,000 50,000 75,000 100,000 75,000 50,000 25,000 0 years 5 years 10 years 15 years 20 years
Loan trust features No immediate IHT effect Settlor has access to outstanding loan at any time Outstanding loan forms part of settlor s estate at all times Variable income (i.e. withdrawal of capital) available to settlor, but limited to amount of loan Any investment growth is outside the settlor s estate from commencement Transferable NRB is still available
The Loan Trust Advantage - Access to Capital & Income 100,000 investment (no withdrawals) Investment Bond not in Trust Term Value IHT @ 40% 5 127,628 51,051 10 162,889 65,156 20 265,330 106,132 Loan Trust O/S Loan IHT @ 40% 100,000 40,000 100,000 40,000 100,000 40,000 The IHT liability has been capped. *Assumed net growth rate 5%pa and Value is above available nil rate band
100k invested - 5 years later Client has taken no loan repayments and remain a higher rate taxpayer. At the start of year 6 the investment bond is now worth 130,696 having grown by 5.5% p.a. net of charges. 30,696 of the investment is outside of the estate for IHT purposes saving a potential 12,278 IHT bill. However the outstanding loan of 100,000 still forms part of the taxable estate on death. Client has now decided that they would like to give up rights to approximately half the loan (Circa 50,000). What options are available to do this?
Disadvantages of demanding repayment of the loan An income tax liability arises on the encashment of (part of) the bond. A loss of control if an outright gift is made to the children. Whilst not a problem in this case, it s possible that the encashment proceeds of the bond may be less than the outstanding loan. In these circumstances the trustees may have to make up the deficit out of their own funds. For the advisor, a reduction in the funds under management. Is there a better alternative?
Option 2: waive some of the loan Client can waive their rights to some or all of the outstanding loan in favour of the discretionary trust. Any waiver of the loan by the Lender will be a transfer of value for IHT purposes. Where this waiver exceeds any available annual exemptions for IHT purposes, the excess will be a Chargeable Lifetime Transfer*. On the basis that the settlor was excluded from benefiting under the trust, this would not give rise to a gift with reservation. To be effective, any waiver must be made by deed otherwise HMRC will not accept it as being valid. * If discretionary trust has been used. Will be potentially exempt transfer if bare trust had been used
Utilising the annual IHT exemption Each year they could use their annual IHT exemption by waiving a further 3,000 in favour of the trust. Trust 3,000 Outstanding loan
Benefits of the deed of waiver option Avoids the encashment of the bond and therefore a potential chargeable event arising. The beneficiaries under the trust benefit from the loan waiver. Funds can remain invested and the trustees have control over the (discretionary) trust fund as to when it is distributed to the beneficiaries. Ultimately, the bond could be appointed/assigned to the beneficiaries this could lead to a lower tax liability on any gains made compared to the Lender requesting a repayment of the loan.
Discounted Gift Trust Female aged 70 NBD 500,000 investment 5% pa income ( 25,000 p.a.) 500,000 Discount 293,056* Split Gift 206,944* CLT/PET After 7 years CLT/PET falls outside of Estate. PLUS client has received 175,000 income *standard terms based upon normal health: Source AXA discounted gift trust calculator 01/04/16
Using DGT differently Client gifted 325,000 into a discretionary trust on the 1 December 2016. They now wish to gift a further 600,000 to an only child to help reduce the potential IHT liability that will arise when he dies. Child is 19 years old and the client is keen to retain investment control over this gift until his death. Which type of trust would you recommend?
Both types of trust have their drawbacks Absolute trust Child has an absolute right to trust capital as they have already attained 18. Discretionary trust Gifts in excess of NRB taxable plus potential periodic and exit charges. The trustees will have an IHT liability 120,000. Is there another solution? A discounted gift trust!
A discounted gift trust using an absolute trust Male, aged 66 NBD, 600,000 investment 0.5% income** 600,000 GRANTEE s FUND 39,430* THE DISCOUNT RESIDUARY FUND 560,570* PET Client could gift the 3,000 income each year to child, utilising his annual IHT exemption. *standard terms based upon normal health AXA IOM discounted gift calculator 09/05/2016 **Income refers to regular withdrawals of capital for tax purposes
A word of warning - what if child predeceases the client? The capital value of the child s interest in the trust property will form part of their estate for IHT purposes. The IHT liability relating to the child s interest under the DGT would be the responsibility of the trustees. As the policy cannot be surrendered whilst the donor is alive, the trustees will have no funds available from which to pay the tax. Life cover could be effected on the life of the child to cover this potential liability. Any life cover should not be effected by the trustees of the DGT. This would inflate the value of the trust and therefore the trustees total liability on the death of the child. Child could effect the life cover on an own life basis and use some of the 3,000 gift from parent to pay the premiums.
Summary The DGT allows a client to make a large gift which falls outside of his estate after 7 years. Using a DGT means that the child cannot receive the trust proceeds until the client s death. Using an absolute trust gives the client no ability to change the beneficiary at a later date. There is no tax charge on creation and no periodic or exit charges. Consideration should be given to the implications of the child predeceasing the client. Client, as a trustee, can also choose how the fund is invested until his death.
What part can pensions play? Post April 2015 75 Unvested 25% LTA charge on excess No income Nominees flexi access drawdown on death Member defers benefits and opts for 25% LTA charge at age 75 No further LTA charge post age 75 Nominees flexi access drawdown not measured against recipients LTA Fund left to beneficiaries who are basic or ideally non taxpayers i.e. grandchildren, so total effective charge could be 25%
Death Benefits generation skipping Client age 74 dies with pension fund Spouse is 5 years younger with a 10 year life expectancy Next generation in their late 40 s Grandchildren are in their early 20 s
Pension tax relief The government decided not to make changes to the age limit at which tax relief can be claimed on pension contributions. This will remain at age 75. Is there still an opportunity to consider pension contributions for individuals over the age of 75?
Pension contributions for individual's age over 75 Funds left in estate at date of death or paid as a pension contribution. Estate Pension 100 100 Tax on death 0% or 40% (IHT) 0% /20% /40%/45% income tax payable by recipient If the member is in good health and the beneficiary is a non or basic rate taxpayer it may still be worth paying a pension contribution. Whilst no tax relief is generated on the contribution careful extract of the fund could ensure that the pension fund suffers no more than 20% in the hands of the recipients potentially beneficial if the estate is liable to IHT at 40%! Employer contributions and deductibility based on wholly and exclusively rules
Important information FOR FINANCIAL PROFESSIONALS ONLY. Information about tax is based on Ascentric s interpretation of current legislation and HM Revenue & Customs' practice. Tax treatment can change and depends on your client s personal circumstances. The information contained in this presentation does not constitute advice. It is designed for financial adviser use only and is not intended for use with individual investors Ascentric is a trading name of Investment Funds Direct Limited (IFDL), part of the Royal London Group. IFDL is authorised and regulated by the Financial Conduct Authority No.114432. Registered in England and Wales number 1610781, VAT number 368524427.
Contact Andy Zanelli By telephone 01225 787 575 By post Trimbridge House, Trim Street, Bath, BA1 1HB By email Andy.zanelli@ascentric.co.uk Ascentric is a trading name of Investment Funds Direct Limited, part of the Royal London Group. Authorised and regulated by the Financial Conduct Authority No. 114432. Registered Office Trimbridge House, Trim Street, Bath BA1 1HB. Registered in England and Wales with Company Registration number 1610781