Inheriting issues

Last autumn\'s easing of inheritance tax criteria is welcome, but it has created fresh issues for advisers, says Sonia Speedy

Changes announced in last year’s Pre-Budget Report may have loosened the inheritance (IHT) net a little, but while the ability to transfer nil rate bands has simplified the regime for many, new issues for advisers to consider have sprung up as a result.

Chancellor Alistair Darling’s first Pre-Budget Report (PBR) last October included the announcement that the IHT tax-free allowance – currently set at up to £300,000 – could be transferred on to a spouse or civil partner, if it was not used upon an individual’s death. The move effectively enables the living spouse to benefit from a total IHT-free allowance of up to £600,000 upon their own death, above which 40 per cent tax is paid.

Previously discretionary will trusts had been used to ensure this allowance was not lost upon the first death, achieved by passing the tax-free amount down – via the trust – to beneficiaries, such as their children.

Ian Dyall, senior estate planning product specialist at Edward Jones says: “For the majority of people all the changes did was enable them to achieve what they could have achieved anyway with a bit of planning.”

However, Danby Bloch, director of Taxbriefs Financial Publishing believes the ability to transfer the nil rate band has promoted a significant change in IHT mitigation and suggests that advisers need to think carefully about the advice they give in this arena.

“It makes quite a difference because now there is a considerable discussion about whether you should still pass down assets at first death or whether you should leave all the assets to pass down at the second death. Or possibly during the lifetime of the surviving spouse,” he says.

While passing assets down at the first death can be a good idea – Bloch says there are arguments either way – the potential future growth in the nil rate band requires consideration.

“Let’s say that the husband dies first and leaves £300,000 to the kids and the wife soldiers on for a number of years after,” says Bloch.

“The years that are coming up now are probably going to see quite an increase in the value of the nil rate band. If you leave the £300,000 to the kids and then the wife dies in seven or eight years time – by which time the nil rate band is £750,000 or so – at that time, with her nil rate band on top of his, what we could have been looking at is £1.5m possibly free of IHT.”

As Bloch says, if the husband had used his nil rate band upon death, the beneficiaries could be left “irritated”, dependant upon how well the investment they made with that £300,000 had grown.

“And of course, they might be irritated with the adviser who suggested they use the nil rate band,” he says.

“There’s a very good case for advisers saying clients should use the nil rate band, but they’ve got to ensure that the client understands it at the time and continues to understand it. Otherwise they are going to get some pretty unhappy clients.”

Similarly, Nick Williams, chartered tax adviser at Clerical Medical says that while there is a reduction in the need for nil rate band planning now, there are still situations where it is useful.

This includes scenarios in which clients want certainty around where and when their assets will be passed on – particularly relevant for clients who have children from a previous marriage, for instance.

Bloch suggests there are ways that clients who want to pass money on to beneficiaries at the first death can do so, without missing out on growth in the nil rate band. This includes transferring the nil rate band to the wife, who then makes a transfer to the children.

That offers the benefit of seeing the amount transferred “fall out” of her estate after seven years for IHT purposes, while leaving the wife with both her husband’s and her own nil rate band to utilise.

However, the money transferred by the wife could not be passed back to her should she need it, as this would fall foul of gift with reservation rules. Whereas, via a nil rate discretionary trust, the money could be loaned to the widow, using up the husband’s nil rate band and leaving a debt in her estate further reducing her own IHT liability.

“So in fact, you could certainly use a loan back to the spouse to double the value of the original nil rate band,” Bloch says.

Dyall points out that there are groups who will benefit from the PBR changes, regardless of whether or not they had discretionary will trusts in place previously. This includes those individuals whose spouse died some years earlier and did not make use of their nil rate band. They can now benefit from their partner’s allowance at the revalued threshold of £300,000. Widows and widowers can make use of the changes however long ago their spouse died.

With many new factors to consider around IHT planning in 2008, it seems that many advisers are sticking to tried and true planning methods and carefully shunning more exotic schemes that may attract the unwelcome gaze of HM Revenue and Customs.

Alan Adam, financial consultant at Alan Steel Asset Management says he recommends people make outright gifts to mitigate IHT or take out insurance to cover any IHT liability. The firm also uses investment bonds in trust, making use of discounted gift rules, where appropriate. “The older fashioned ideas are sometimes still the best ones,” he says.

Dyall says Aim shares are another IHT planning tool that is relatively popular in the market, although he is cautious about their use. Some Aim shares can qualify for business property relief, which means that after two years they can fall out an estate for IHT purposes. “Which is very attractive to many people, particularly the older people because they think well I’m not going to live seven years, but I might live two,” Dyall says.

Under inheritance tax rules, gifts made with seven years of death can still be added back into the estate. “The danger with Aim shares is – we’ve seen the volatility in equity markets over the recent 12 months – obviously amplify that for Aim shares because they are less liquid. Then you take a two year snapshot and no-one really knows whether they’ll actually go up or down.”

Margaret Jago, technical manager at Aegon Scottish Equitable International says that despite the PRB changes, it is still seeing use of the main trusts types, including gift trusts, loan trusts and discounted gift arrangements.

“With things like higher house prices and so on, we’re really still expecting that trust planning will be quite a meaningful part of people’s activities at the higher net worth end of the market.”

However, she too notes a trend towards more conservative IHT planning. “We certainly get quite a lot of requests about whether we’ve had challenges to our plans, whether we’re using Revenue agreed methodology – that sort of thing,” she says.

Williams too suggests that there are very few “whizzy-bang” IHT schemes around these days, with Clerical Medical recently putting out a guide to simple estate planning for IFAs. In addition to those methods previously mentioned, Williams suggests that utilising deeds of variation to change who benefits from assets that are ºinherited and maximising use of pension contributions are other useful tools.

Darling’s IHT changes triggered a bitter war of words between Gordon Brown and David Cameron, who accused Labour of stealing Conservative policies. But they have certainly sweetened the pill for those facing death duties.

Case study – Planning for IHT

Martin Bamford, joint managing director, Informed Choice

“People are either dead-set against paying inheritence tax or they’re pretty blasé about it “