How to maximise IHT savings using the nil-rate band

IHT SavingsThe Residence Nil Rate Band (RNRB), introduced from 6 April 2017, is the greatest change to inheritance tax (IHT) in more than 10 years.

It also marked the first time in the history of this tax that the way it operates changes according to the relationship of a person benefitting (other than the traditional spouse exemption).

RNRB makes a major rethink of estate planning necessary, just as it is becoming well understood that wills (and trusts owning interests in properties) also need re-thinking to make the most of this valuable new relief. What does the reference to estate planning mean?

Estate planning is the integration of three disciplines, legal, tax planning and financial planning.

With the significant up-skilling of financial planners, working to higher levels of qualification than the old style IFAs, there is potential for three sets of professionals to work together: lawyers, tax advisers (some of whom may be accountants) and the new breed of financial planners, although many lawyers will also offer the specialist tax advice needed so that it can all be done by two advisers.

If anyone is planning to start drawing on a pension it is good to stop and ask if advice has been taken since the major reforms.

The introduction of RNRB makes estate planning ever more crucial and important that these advisers work together. Why?

RNRB is a valuable relief worth currently a saving of £40,000 or £80,000 of IHT (the latter for a widow(er) or married couple), figures that increase to £70,000 and £140,000 of IHT saving in the tax year 2020/21 when the RNRB will be £175,000 for one, or £350,000 for a couple or a widow(er).

Those potential tax savings can be put in jeopardy by two major restrictions:

  1. The taper threshold of £2m, so that estates with a value over that limit lose £1 of relief for every £2 excess. This amounts in effect to a marginal IHT rate of 60 per cent on the band of capital over £2m. With the current RNRB of £100,000, or £200,000 for a married couple, it means the full benefit of RNRB is lost with an estate of £2,200,000 or £2,400,000 respectively.
  2. The traps for gifts left by will or trust, as to how they need to be left to secure the relief, which can mean beneficiaries who should qualify paying unnecessary extra tax. These traps can easily catch the unwary.

Space does not permit consideration here, but suffice to say proper advice should be taken from someone who is confident at dealing with RNRB. It is very complicated, and can guide clients round the traps.

Lawyers who are members of the Society of Trust and Estate Practitioners (Step) might be a good place to start if people are looking for someone to talk though the legislation.

Understanding how the £2m threshold works:

What’s included in the estate for the £2m threshold? The total “estate” includes the value of any trust which is aggregable with (added to) the personal estate of the deceased in working out the IHT payable on death.

Generally this means trusts in which the deceased had an entitlement to income, such as the immediate post-death Interest (IPDI) in an estate since the last major reform of IHT in March 2006.

What’s the effect of business and agricultural reliefs (BPR/APR) and spouse exemptions? The £2m does not take any account of exemptions and reliefs. So it makes no difference how much APR or BPR there may be.

Many clients who hold most of their assets in their farm or business may assume that this £2m limit does not apply to them but, like so many elements of RNRB, this would be a false assumption.

Likewise it doesn’t matter if there is a spouse exemption for all or part of the estate.

Lifetime gifts are not taken into account, so long as gifts have been completed. Lifetime gifts made within seven years before death would normally be caught for IHT, increasing any tax payable on death.

However, strangely they are not currently taken into account in assessing the £2m threshold. They simply need to be complete gifts, for example, if cheques, they need to be presented and cleared.

What’s not included?

Life cover written in trust, so that the proceeds are outside the life assured’s estate, and pension death benefits due from a pension scheme are both excluded.

Life assurance designed to pay out on death (or the death of surviving spouse), to help meet the IHT bill payable, is less common that it was in the previous decades. But for many it still produces a significant sum.

A negligence case in 2016, Herrings v. Shorts Financial Services, involved a claim against a financial planner for not advising a client on the effect of an old life policy written in such a trust, knowledge of which would have changed the way the personal estate was left.

On the facts the financial planner was not liable, but it reminds us that clients often forget they have taken out forms of life cover and investment over the years, which may affect what they should do with their other assets on their death.

Pension death benefits (PDBs) are even more important than life cover, as the amounts can be significant and the tax benefits of leaving PDBs to family have been radically improved by former chancellor George Osborne’s reforms of 2015/16.

These generous reforms may be vulnerable to change in these more challenging times, not being seen as a priority in a world of those just about managing (the so-called JAMs), but while still in place they are worth using well.

Spouses and the £2m threshold

Many spouses may consider their estates are not over the £2m level, not realising that when the two estates combine the total value may exceed £2m.

Many that are just over £2m may then effectively be “caught twice” if on the death of the first spouse the limit is exceeded, reducing or losing the relief, and then the capital being inherited (either outright or in an aggegable trust) by a spouse who’s estate may now be taken over the cliff edge.

In that way, one lot of capital can be caught a second time, losing RNRB a second time. Planning between spouses thus needs to be re-thought, as per the third opportunity outlined below.

So how can advisers plan to help their clients to secure RNRB, with £1m to £5m estates, and avoid paying a 60 per cent marginal IHT rate?

There are three key opportunities to explore here:

1) Planning to spend other capital in one’s lifetime, keeping back pensions – so pension death benefits can always be left to family tax effectively later.

If everything over £2m is effectively taxed at the rate of 6 per cent, when the 40 per cent IHT rate combines with the loss of RNRB by tapering, it means that spending every £100 of capital in the band over £2m can cost the estate only £40.

So spending investments, capital that will otherwise be subject to that tax, is very cost effective. Especially if what is left behind is something that has a special tax status, such as an Alternative Investment Market investment that qualifies for BPR for IHT, or a pension scheme.

If anyone is planning to start drawing on a pension it is good to stop and ask if advice has been taken since the major reforms – the introduction of RNRB in April 2017 and the benevolent changes to the taxation of pension death benefits (PDBs) in 2015/16.

Those pension reforms included opening the option of leaving PDBs to beneficiaries nominated (“nominees”) even if they are not dependants.

Thus adult children, their families, for example, could be included, not just minor children, spouses/partners and others dependant on the deceased.

What’s more, PDBs can be paid so that in many cases the benefit received is taxed as income at the marginal rates of the recipient.

The new top option of flexi-access drawdown (FAD) allows a part of a pension fund to be allocated to a beneficiary for him/her to draw down at their choosing, or to pass on to successors, such as their children or spouses.

This can be really good tax planning and opens whole new possibilities that no-one ever thought about before when pensions were just about a secure income in retirement.

These reforms may not last for long in the current format but while they do are well worth using fully.

2) Spouses planning between them to avoid unnecessarily adding to the second estate (or an aggregable trust) which might take the second estate over £2m.

How spouses arrange their estates, what they leave to each other and whether they use a nil-rate band discretionary trust (NRBDT) on the death of the first spouse, take us into will drafting, which is not covered here.

It is, however, part of what needs to be considered, with NRBDTs now having a new lease of life as a way of extracting capital value out of the first estate so that it does not add more to the second estate than necessary.

Such trusts give the surviving spouse access to capital or the use of property without the asset values being taxed with the survivor’s estate (they are not aggregable). An invaluable tool to help reduce below the £2m threshold.

3) Lifetime gifts, even if “deathbed” gifts, to reduce the estate below £2m.

This opportunity, while it is still available, may be a valuable last line of defence, to use alongside points 1 and 2 above, or if too late for anything else.

Spending capital can always be combined with giving it away. In this case, we are not worried about the donor of any gift surviving for seven years from the date of the gift. It does depend upon the donor having mental capacity to make valid gifts of capital.

If the gift being made is the deemed gift of terminating a life interest in an aggregable trust, and if there are trustees able to make decisions, gifts like that can be made more easily, and can be an invaluable element of tax planning.

In many cases, a surviving spouse is a trustee with another person (whether a family member, professional person or someone else) and so it can be sensible planning to consider with such surviving spouses whether he or she might retire as a trustee.

They could do so in favour, say, of an independent person when they are getting older and maybe showing early signs of a declining capacity.

Another option for lifetime gifts is giving a home which is lived in to individuals or a trust and paying a full market rent. Such a rent avoids a reservation of benefit, which is where a proper gifted is still occupied, and can be worth doing for a relatively short period where someone knows their lifespan is short.

A terminal diagnosis could lead to someone making such a gift provided they have proper advice/negotiation on what is a full market rent for occupying the property.

Estate planning means all the above need to be considered as part of an overall strategy for meeting the needs and comfort of the moderately wealthy in the £1m to £5m bracket.

By the different specialists working together, better results can usually be achieved for clients.

By |2018-01-24T11:57:31+01:00January 20th, 2018|News|

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Local independent financial advisers based in Haxby, York. Corville Wealth Managements offers professional and straight forward advice to all clients.