Benjamin Franklin once famously said that the only two things that are certain in life are death and taxes. Unfortunately, in the case of inheritance tax, both can occur at the same time and have an equally devastating effect on your family.
However, despite what you might read in the press, inheritance tax (IHT) is actually a voluntary tax and with some careful planning it is possible to reduce or avoid it.
With the current IHT allowance set at £325,000 and the average UK property at £226,887 it’s not difficult to see how many households with some savings, life assurance and property could come within reach of this 40% duty. If you have been a basic rate income tax payer all your life it is going to be more than a little galling to finally break through into the higher rate once you’re 6 feet under.
There are many basic steps you can take to reduce the effects of IHT. These include keeping your will up to date, making effective use of allowances and putting any life cover in trust. But what about the larger part of your estate and in particular any investments you hold.
The next step is to probably start gifting some of these assets whilst you are still alive. Whilst this does eventually have the desired effect, it is important to appreciate that money (or any other assets) given away before you die are still usually counted as part of your estate for 7 years after making the gift. The bigger issue for most people with making larger gifts is that you have to relinquish ownership and any further entitlement to the asset in the future.
So what are the options available if you want to try and reduce your IHT liability but still need that access to either your capital or an ongoing income? As a general rule of thumb the more access you need to your original investment the more protracted the IHT benefit.
If you are looking to retain access to your original capital then a Loan Trust might be the solution. Having set up a trust you lend the trustees (of which you are one) a sum of money to invest. All growth on the investment will immediately fall outside your estate but you retain the right to repayment of the original loan in full at any time, although it is normally in the form of a regular income. On death only the balance of any repaid loan is included within your estate for IHT.
If you want to move the money out of your estate quicker than this but still need an income from your investment, the answer may be a Discounted Gift Trust (DGT).
A DGT will allow you to make a gift which is held for the ultimate benefit of your nominated beneficiaries, whilst providing you with a series of withdrawals, payable for the rest of your life. These withdrawals must be specified at outset and cannot be varied thereafter.
Providing you survive 7 full years from the creation of the trust then the full value of the gift will be outside of your estate for IHT purposes.
As the withdrawals are for your absolute benefit, they are not deemed to be part of the gift you made to the trust for IHT purposes. As such, should you die within 7 years of creating the trust HMRC should agree to ‘discount’ the value of the transfer by the amount of your retained right to the income, effectively making a reduction to your liability from day one.