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Investment planning should be a continuing process to ensure your investment aims are still right and your investments correctly aligned with those objectives.

Inheritance Tax Planning (Part 2) - Published August 2016

Estate planning is often conceived hand-in-hand with inheritance tax planning involving the creation of structures such as trusts, wills and powers of attorney. The former demands tools and logic to “tidy up” your affairs before dying. For the latter, the awareness of any potential liability does not usually register until later in life.

As people grow older they become more aware of the potential IHT liability on their estate. However, the earlier IHT planning starts, the easier it is to reduce the eventual tax bill. Forewarned is forearmed and now lets proceed with Nº 2 in this series with the use of Potentially Exempt Transfers (PETs).

PETs may provide individuals with valuable tax-saving opportunities, if you can afford to make gifts of substantial amounts, normally to your family. The main advantage of a PET is that there is no lifetime IHT charge, regardless of the amount gifted. Therefore, even if the gift exceeds the nil rate band, it will not incur an IHT charge of 20% on the excess. However, if the donor does not survive the seven-year PET period, IHT may be payable if the amount gifted is not covered by the donor’s nil rate band. For gifts in excess of the nil rate band which become taxable, taper relief may be available if death occurs after three years of making the gift. Taper relief effectively reduces the amount of IHT payable on the gift on a reducing scale once the donor has survived three years.

Gifts to bare (absolute) trusts are treated as PETs and an advantage of this type of trust is that there is no periodic or exit charge on the value of trust assets, although the trust is inflexible in nature.

• It is important to consider any Capital Gains Tax (CGT) consequences of gifts. A gift to a spouse or civil partner will be a no gain, no loss disposal provided they are living together, whereas a gift to any other person will not be.

• By covering the possible IHT liability on a PET with a seven-year term life assurance policy, clients can make lifetime gifts without fear of the impact of tax on a premature death. If a PET is made in excess of the nil rate band, any potential liability to IHT on that excess could be covered by a form of decreasing term assurance over seven years.

• Several factors must be taken into account when considering possible PETs of business or non-business assets:
1. Whether the assets produce income that is needed.
2. The level of IHT business relief on gifts of such shares or other business assets.
3. The availability of CGT holdover relief for gifts of business interests. CGT is chargeable on a gift of an asset as if the asset had been transferred at market value.
4. Whether the client should maximise their pension provision before making a gift of private company shares or other business assets. 

There is now significantly less scope for taking advantage of the PET rules. Lifetime transfers into flexible type trusts are now chargeable lifetime transfers (CLTs), not PETs. Thus, for most practical purposes, a PET must be an outright gift (either to an individual or to a bare (absolute) trust).

Look out for the next and third article in this series on Inheritance Tax Planning when we will identify the pitfalls and the tax issues related to Chargeable Lifetime Transfers (CLTs) and how you can avoid these, simply by making gifts in the right order.

This article is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investments or course of action.  Taxation depends on individual circumstances as well as tax law and tax authority practice which can change.  Not all IHT planning is regulated by the FCA.

Raoul has a weekly radio feature (Raoul’s Rant) on the Owen Gee Solid Gold Sunday morning show on KissFM Algarve.