A guide to inheritance tax (IHT)

A guide to inheritance tax (IHT)

Important notice This guide has been designed to provide general information about inheritance tax ( IHT ) and should not be regarded as investment or taxation advice. Tax rules are complicated. This guide does not cover all the tax rules. In many cases, certain personal circumstances may affect how a rule works for you. Any IHT planning should be undertaken in conjunction with a suitably qualified adviser. You should only make an investment on the basis of the information provided in the relevant product literature, and we always recommend that you take professional independent financial and taxation advice before making any decisions to invest. Investments in unquoted companies or companies quoted on the Alternative Investment Market ( AIM ) are higher risk by nature and therefore may not be appropriate for everyone. Find out more about the key risks on page 9. This document has been approved and issued as a financial promotion under the Financial Services and Markets Act 2000 by Downing LLP ( Downing ) and is intended for investment professionals only. If you forward this to any other person, you must ensure that you have taken responsibility for it under the financial promotion rules. This document does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities, or to enter into any investment service, and no reliance should be placed on it. Downing is authorised and regulated by the Financial Conduct Authority (Firm Registration No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD. Get in touch If you have any questions, or would like to discuss our IHT relief products, please call us on 020 7416 7780 or visit www.downing.co.uk. Information correct as at 5 September 2017.

Introduction Inheritance tax ( IHT ) is a complex topic. We ve created this guide to help you understand the estate planning options available to you, although we recommend that you speak to a professional financial adviser before making any decisions. IHT is the tax on the estate that an individual leaves behind when they die. An estate includes any property, money or other assets once any debts, such as a mortgage, have been paid off. Nil rate band A certain amount of your estate can be passed on tax-free, which is known as the nil rate band. Currently, the nil rate band is 325,000 per person, which is frozen until 2021. Anything above this nil rate band is subject to 40% IHT (or 36% if the deceased leaves 10% or more of their estate to charity). Residence Nil Rate Band (RNRB) In April 2017, the government introduced an additional allowance which applies to the family home that is transferred to direct descendents, known as the RNRB. This allowance starts at 100,000 per person and will increase over four years to 175,000 per person. This will effectively raise the IHT-free allowance to 500,000 per person in 2020. However, estates worth more than 2 million will be subject to a taper; for every 2 above 2 million, the RNRB will be reduced by 1. This means that joint estates worth 2.7 million and over will not benefit from the RNRB. IHT for married couples and civil partners Any part of an estate that is left to a spouse or civil partner is exempt from IHT, as long as they permanently reside in the UK. When a spouse or partner passes on, any unused portion of their IHT-free allowance goes to the surviving partner, meaning that they can double their nil rate band to 650,000 when they die. If you include the Residence Nil Rate Band, this will be equivalent to a total IHT exemption in 2020 of 1,000,000 for the remaining partner or married couples that jointly own a family home and want to pass it on to their children. Key facts: IHT 4.7bn IHT receipts in 2015/16 - a record high 1 +22% The equivalent increase since 2014/15 1 Almost 30% Homeowners aged over 70 that haven t considered estate planning or IHT mitigation 2 1 Source of all data: HMRC IHT Statistics, 29 July 2016, 2 Source: Intelligent Partnerships BPR Industry Report 2016 You ve worked hard to build your estate - take control of who benefits from it A guide to inheritance tax 3

How does IHT affect me? According to HMRC IHT Statistics, the 2015/16 tax year saw 4.7 billion of IHT receipts - a 22% increase on the previous year 3. IHT tax receipts have continued to rise since 2009/10 3, as the 325,000 nil rate band introduced in April 2009 hasn t increased. The 2015/16 tax year saw the highest IHT receipts since the current system was introduced in 1986 3. Each year, residential property makes up approximately one third of the total value of taxpaying estates 3. With house prices increasing 3, and the nil rate band frozen until April 2021, it s no surprise that an increasing number of people are finding that their estates will be subject to IHT upon their deaths - even with the Residence Nil Rate Band. How is IHT applied to an estate? To help you understand how IHT is applied to an estate, here is a worked example based on the IHT liability of a single person: Value of estate on death: 1,000,000 This is the sum of everything you own, or the share of anything jointly owned (including property, savings and investments), minus any outstanding debts, anything left to charity and the reasonable costs of a funeral. Nil rate band: 325,000 Taxable estate: 675,000 IHT bill at 40%: 270,000 Remaining to pass on: 730,000 Please note, this example is set out for illustrative purposes only to demonstrate the effect of 40% IHT. IHT liability is subject to personal circumstances. How does marital status affect IHT liability? ffif you are single or unmarried: the value of your estate over the nil rate band ( 325,000) will be subject to up to 40% IHT. ffif you are married or in a civil partnership: you can pass any of your estate onto your spouse or civil partner IHT-free. The value of your estate over 325,000 which is passed on to anyone other than your spouse or civil partner is subject to up to 40% IHT*. ffif you are widowed: if your spouse or civil partner passed on an estate worth more than 325,000 to anyone other than you when they died, you will not benefit from their nil rate band. Up to 40% IHT will be due on the value of your estate over 325,000 when you die*. If your spouse or civil partner left you everything and did not make any gifts during their lifetime, you can combine their nil rate band with yours, meaning that up to 40% IHT would be due on the value of your estate over 650,000*. *The Residence Nil Rate Band will apply to the family home, starting at 100,000 in April 2017 and increasing to 175,000 per person in 2020. 3 Source: HMRC IHT Statistics, 29 July 2016 4 A guide to inheritance tax

A guide to inheritance tax 5

How do I plan for IHT? It s a good idea to consider planning for IHT, so you can pass on as much of your wealth as possible to your loved ones when you die. Paying the IHT bill Your IHT liability is usually paid from your estate, after all debts have been settled, and is normally payable within six months from the end of the month in which the death occurs (after this time, interest is charged on the unpaid amount). Usually the executor of the will or the administrator of the estate pays IHT using funds from the estate. An executor is a person or persons named in the will to deal with the estate. An administrator is the person who deals with the estate if there s no will. Under certain circumstances, tax on some assets, like land and buildings, can be paid in instalments over ten years. If the asset is sold before all of the instalments have been paid, the outstanding amount will be due in full. Leaving assets to your spouse or civil partner As any gifts that you give to a spouse or civil partner are exempt from IHT, it s often the easiest option to take. This applies to any gifts made while both parties were still living, or if they were left to the surviving spouse or civil partner on death. Making a will It s important to leave a will to ensure that your estate is passed on in line with your wishes, whether you want your assets to go to your loved ones or left to your favourite charity. If you make a will you can also make sure you don t pay more IHT than you need to. This can be particularly important for couples that aren t married, or in a civil partnership. You can write your will yourself, but we recommend that you seek legal advice. Remember, in order to write a legally binding will, you need to be: ffat least 18 years old; ffa UK resident; and ffable to understand the consequences of what you are doing ( of sound mind ). Your will also needs to be formally witnessed and signed to make it legally valid. If you die without having a will (also known as dying intestate ), the law decides how your estate is passed on and if you don t have any close relatives, your assets could end up in the ownership of the government. Example: The importance of making a will Diane and Joe have lived together for 20 years and have three children, but are unmarried. Joe owns a majority ( 600,000) of their assets, including the family home, with Diane owning the remaining 400,000 of assets. Neither makes a will as they assume that as they ve been together so long, their assets will go to the other partner when they pass on. In fact, both of their estates will be affected by IHT: Value of Joe s estate on death: 600,000 Nil rate band: 325,000 IHT liability at 40%: 110,000 As Joe did not have a will, the remaining assets will pass straight to his children, with no provision for Diane. When Diane passes away, her estate will also be liable for IHT at 40%. 6 A guide to inheritance tax

160% The increase in the number of family estates affected by IHT between 2010 and 2015 Source: Office for Budget Responsibility A guide to inheritance tax 7

What are my options? There are three main IHT planning solutions available: gifts, trusts and Business Relief (BR). We recommend that you talk to a qualified independent financial adviser, who can help find the right solution for you. Gifts You can gift your assets away to mitigate your IHT liability, up to a total value of 3,000 per year (the annual exemption ). Any leftover annual exemption can be carried over from one tax year to the next, but only to the next tax year. Any gifts you make will fall outside of your estate once seven years has passed since the gift was made. Any gifts made less than seven years before death count towards the IHT threshold, although the rate of tax is reduced for gifts over the threshold that were made between three and seven years before death ( taper relief ). Certain gifts don t count towards the annual exemption and no IHT is due on them, such as wedding (or civil service) gifts worth up to 5,000 given to a child, 2,500 given to a grandchild or great-grandchild and 1,000 given to anyone else. There is also no IHT on individual gifts worth up to 250. You can give as many people as you like up to 250 each per tax year, unless you have given that person a gift using a different exemption (such as the 3,000 annual exemption). If you give someone more than 250 in a tax year, the whole amount will count towards your IHT bill. IHT is not payable on gifts to charities, museums, universities, political parties or community amateur sports clubs. Remember, any gifts between married couples or civil partners are exempt from IHT, as long as they both live in the UK permanently. Trusts Trusts are a popular option for people looking to ensure that assets are passed on to their beneficiaries in a timely, controlled manner while mitigating their IHT liability. Trusts can be designed to release assets when the beneficiaries reach a certain age for example, if you would like to pass assets directly to your grandchildren once they reach the age of 18. Please note that once you place assets in a trust, you lose control of them. It s also possible to place existing life assurance policies into a trust, or take out new policies written in a trust to cover an IHT liability. However, this could be expensive and is typically subject to medical underwriting. In some cases, cover may not be available due to age or health. There are different types of trusts available, including: ffbare trusts (or absolute trusts), which entitle beneficiaries to all the assets held within the trust. A trustee (a person appointed to manage the trust) will look after the assets on behalf of the beneficiaries, and transfer the assets when required. ffdiscretionary trusts, where trustees legally own the assets in the trust and are responsible for deciding how to use the trust s income and capital for the benefit of the beneficiaries. Discretionary trusts can be useful for providing money for the future, such as for a grandchild s school or university fees but are subject to a chargeable lifetime transfer of 20% on anything over the nil rate band. f f Discounted gift trusts, which are usually set up to manage an investment. Individuals can gift a lump sum into a trust, but still receive the income paid out by the investment. A discounted gift trust is a popular way to mitigate IHT on an investment, while retaining access to the income from the investment itself. 8 A guide to inheritance tax

BR Established in 1976, Business Relief (formerly Business Property Relief) was set up to allow businesses to be passed down either IHT-free, or at a reduced rate. BR is available on UK trading companies that are not listed on any major stock exchange and some trading companies listed on the Alternative Investment Market (AIM) or the NEX Exchange Growth Market. There are some exclusions, such as financial companies or those that deal in land or buildings. Individuals can also invest in services that offer BR-qualifying investments. There are investment products on the market that are specifically designed to invest in BR-qualifying companies. These investments are not subject to IHT when the investor dies, so long as the shares have been held for a minimum of two years at death. If a spouse or civil partner dies holding the investments within two years, the investments can be transferred across to the surviving spouse or partner to avoid resetting the two year clock. Please note that investments in non-listed companies carry higher risk than those listed on a main stock exchange. There are many benefits to using BR in estate planning, such as: ffspeed: BR-qualifying investments are exempt from IHT after two years (so long as the shares are held at death). In comparison, trusts and gifts can take up to seven years to become IHT-free. ffaccess and control: investors usually have access to, and control of, their funds (although, please note that any money taken out of a BR investment may become subject to IHT). ffincome: BR investments may also provide investors with regular distributions or income from their investment. ffsimplicity: in comparison to trusts and gifts, which may have complex legal structures or require medical underwriting, BR investments are relatively straightforward. Additionally, power of attorneys are eligible to make BR-qualifying investments without restriction, as the assets remain the investor s and therefore no application to court is required. Key risks There are risks to investing in BR products and it is important that you understand them. Before making a decision to invest you should speak to a financial adviser and refer to the relevant product literature for full details of the risks to make sure you re comfortable with them. The key risks are listed below. ffcapital is at risk: you may not get back the amount invested. fftax reliefs are not guaranteed: rates of tax, tax benefits and allowances are based on current legislation and HMRC practice and depend on personal circumstances. These may change from time to time and are not guaranteed. Tax reliefs depend on investee companies maintaining their qualifying status. ffinvestments are high risk: investments in unquoted companies and those listed on AIM or the NEX Exchange Growth Market are likely to have higher volatility and liquidity risk than shares quoted on the London Stock Exchange. ffpast performance: past performance is not a reliable indicator of future results. At Downing, we offer a variety of BR products that can help you mitigate your IHT liability. Find out more about these on page 10. Example: Using BR to mitigate IHT Edith, 70, is a widower with two children. She has a portfolio of shares worth 200,000 and property worth 750,000. Her available Nil Rate Band is 650,000 as her deceased partner left her everything and did not make any gifts in their lifetime. She also has an additional 100,000 RNRB as she will be leaving the property to her children. Edith wants to mitigate IHT but is concerned that she may not be able to pay any long-term care fees if she gifts her funds to a trust and is unable to access her funds if needed. Value of Edith s shares on death: 200,000 Nil Rate Band: 650,000 Residence Nil Rate Band 2016/17: 100,000 These allowances are utilised on the family home, worth 750,000. Total IHT payable at 40%: 80,000 A potential solution: BR Edith sells her shares and reinvests the proceeds into a BR estate planning service, like the Downing Estate Planning Service. After two years, the BR shares should be IHT-free (so long as she continues to hold them at death). In addition, the Downing Estate Planning Service offers Edith regular distributions (subject to liquidity) that she can use to supplement long-term care fees. A guide to inheritance tax 9

The Downing Estate Planning Service Our estate planning solution may help you mitigate IHT. Key points Date launched February 2013 Assets under management 277 million (as at 30 June 2017) Sector Asset-backed and energy Underlying businesses >50 Tax benefits Asset protection options? Distributions available IHT-free after two years (shares must be held for two years and at death) No maximum investment Yes - there are two options: 1. Standard - Downside Protection Cover: this policy is designed to reduce the impact of loss to you during a minimum of the first two years before your investment qualifies for IHT relief. In the event of death under the age of 90, it covers a loss in value of up to 20% on your net initial investment - with no medical questionnaires or exclusions for pre-existing conditions and at no extra cost. 2. Optional - Life Cover: this policy is designed to mitigate the effect of IHT, for the first two years before IHT relief begins for those under the age of 85 (from the date the shares are acquired). The policy covers 40% of your original gross investment upon death, subject to certain conditions (please note, if the conditions are not met in full, the policy will not pay out). This is an option and is subject to higher fees, as set out in the DEPS Brochure and Terms and Conditions document. Please read the Terms and Conditions for full details and conditions on both policies. Six-monthly (subject to liquidity) Exit opportunities Monthly (subject to liquidity and 10 days notice) The tax benefits and allowances listed above are based on current legislation and HMRC practice and depend on personal circumstances. These may change from time to time and are not guaranteed. Tax reliefs depend on the underlying businesses maintaining their qualifying status. Investments in unquoted companies and those listed on AIM and the NEX Exchange Growth Market are likely to have higher volatility and liquidity risk than shares quoted on the London Stock Exchange. 10 A guide to inheritance tax

About us At Downing, we design and manage investment products that help investors look after their financial wellbeing, while our investment partnerships support businesses in their ambitions. In uniting the two, we build lasting relationships that become the foundation of our investment community. Since 1986, over 35,000 investors have been a part of what we do and we are proud to have raised more than 1.7 billion in supporting the growth of small UK businesses. Find out more To find out more about our Inheritance tax solutions, visit: www.downing.co.uk/investors/inheritance-tax-relief and speak to your financial adviser. A guide to inheritance tax 11

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