Summer revision – Key steps in inheritance tax planning

According to data recently published by the HMRC, the receipts from IHT during the period from April 2021 to March 2022 totalled £6.1 billion, which is a nearly 13% increase on the same period a year prior.

We have had an increase in the number of death estates due to the increases in mortality mentioned last month. This, coupled with the increased house prices, as well as the growth in investment values over the year prior to the Ukraine war and the fact that the nil rate band for IHT has not moved since 2009 and will remain at its current level at least until 5 April 2026, means that things are only going to get worse (better for the Treasury). In fact, the Office for Budget Responsibility estimates that IHT receipts will increase by a further 36% to £8.3bn by 2026/27as more estates will be caught by IHT in the coming years.

Evidently, more can be done to help clients mitigate these potential tax liabilities. This month, we will review the key steps that clients should undertake to mitigate IHT, paying particular attention to ensuring that the available reliefs and allowances are used to the full.

CALCULATE THE SIZE OF THE POTENTIAL PROBLEM

This will involve a review of the current assets and liabilities, the history of any gifts already made, and the client's will provisions. Based on this, the current potential IHT liability on the death of the client can be calculated if nothing is done to mitigate it.

A review of the history of gifting will give an indication of the likelihood of the client being willing to make further gifts. Indeed, there may already be a pattern of regular gifts out of income. This is a great way of estate reduction as such gifts will be exempt from IHT. This will also determine the availability of the remaining nil rate band for IHT.

Establishing the client’s personal circumstances will be of utmost importance: whether married/in a civil partnership, and if so whether previously married/in a civil partnership/widowed; divorced; the existence of children, grandchildren/stepchildren, etc. Married couples and civil partners are frequently treated as one unit for the purpose of fact finding. That is probably not the best approach, unless the clients are determined that on the first death all the assets pass to the survivor. Establishing the personal circumstances of each client and their will provisions will determine whether a residence nil rate band (RNRB) or transferable nil rate band (TNRB) would be available.

A very important point to remember is establishing whether the client has any interests under existing trusts that are qualifying interests in possession (IIPs), i.e. such that the value of the trust fund is in the estate of the client, and, if so, who will benefit on the client's death. There are a number of individuals who have transferred their home (and possibly other assets) to a trust under which they have a life interest, for 'probate' or care home protection purposes. Often such a client will be under the — mistaken — impression that they still in fact own the house. While it may be in their estate for IHT purposes, it's not the same as owning it. Furthermore, such trusts will be treated differently depending on whether they were created before 22 March 2006 or after 21 March 2006.

Having established the facts, an IHT liability if no action is taken can be calculated for each client, each of a couple, depending on who dies first.

ASSET BASED LIFETIME PLANNING

It is useful to split client's assets into groups for this purpose: owner occupied property, second/holiday property, business assets, and cash/investments.

A question will then be asked to each group as to whether continuing access and/or control need to be maintained. The problems of gift with reservation (GWR) provisions and the pre-owned assets tax (POAT) charge are well known in relation to property and, unless joint occupation is a possibility, gifting of a home is not generally recommended. In relation to second properties — such as buy to let or holiday homes — it is usually easier to make lifetime gifts without infringing the GWR provisions, even if the donor intends to use the property occasionally. However, it is also necessary to take into account the POAT provisions as 'occupation' is widely construed for these purposes.

Avoiding these provisions can be achieved using the co-ownership route, or by the donor paying rent for the time spent in the gifted property. Both are based on the commerciality underlying the arrangement. These options may be particularly suitable for a holiday home which the donor would either want to use only occasionally or in proportion to the share of the property they retain — the latter when the property is transferred into joint ownership.

Where a client owns a business or a share in it, the availability of business relief will need to be verified. If 100% relief applies, lifetime gifts will not make any difference for IHT purposes, unless potential sale is contemplated at some stage.

Finally, cash or investments are the easiest category for lifetime planning. Here again the question will be of the need for control and access. While control can be maintained by using an appropriate trust, the problem of continuing access is more difficult, given the above mentioned GWR provisions. Fortunately, here we have assistance of a variety of IHT mitigation schemes involving investment bonds:

• Loan trusts and Gift and Loan trusts where the settlor's right is restricted to the repayment of a loan they have made to the trustees. These could be based on discretionary or bare trusts.
• Discounted gift trust (DGT) schemes where the settlor retains a right to a series of fixed capital payments funded by withdrawals from the bond, held under a discretionary or bare trust. These may be set up with a life insurance or a capital redemption policy.
• Flexible reversionary trusts where the settlor is entitled to the proceeds of a bond at a certain time in the future, including arrangements where the retained rights can be varied or defeated by the trustees.

The IHT consequences of gifts will have to be considered, especially having regard to any chargeable lifetime transfers (CLTs) already made. CGT consequences of gifts other than cash will also need to be considered. Gifts to individuals and to absolute (bare) trusts will be potentially exempt transfers (PETs). Gifts to any other trusts will be CLTs.

If the asset gifted qualifies for 100% business relief (e.g. shares in a private unquoted company), the value of the gift for IHT (when made) will be nil regardless of the actual value. However, if the donor dies within seven years of the gift, the value of the gift will have to be recalculated without business relief if the donee has in the meantime disposed of the asset.

A gift into a trust rather than an outright gift may offer continuing control and more security and so may be more acceptable to a potential donor. If total access is needed so that a gift is inappropriate, investments qualifying for IHT business relief, such as EIS or AIM shares may be considered for a client with an appropriate risk profile.

REVIEW OF WILL PROVISIONS

Many married/civil partners clients still have wills made before the TNRB was introduced in 2007. If drafted professionally, such wils would normally include a discretionary nil rate band trust. Prior to 2007 this was often recommended as the only method of banking the deceased's nil rate band on the first death of a couple. If not used, the nil rate band was lost. While this is no longer necessary for tax reasons, there may be practical reasons such a trust might still be useful. This would need to be fully discussed with the clients.

On the other hand, if the only reason that a couple have included nil rate band discretionary trusts in their pre-2007 wills was to 'bank' the nil rate band — and especially where the nil rate band legacy was to be satisfied by an IOU or a charge on the couple's home passing to the survivor — then they definitely need to review their wills and make new ones.

Where a client has children or grandchildren, and their estate includes a residence, it's important to remember that the will should ensure the RNRB is available. This means that the property needs to pass to those children/grandchildren, etc. 

As there is still quite a lot of confusion about the availability of the RNRB where will trusts are concerned, here is a useful reminder of the rules. It will only be available in the following cases:

• a bare trust for a lineal descendant (or their spouse/civil partner)
• an IPDI trust for a lineal descendant (or their spouse/civil partner)
• a disabled person's trust for a lineal descendant (or their spouse/civil partner)
• an 18-to-25 trust
• a bereaved minor's trust (BMT)

For those who wish to maximise the use of the RNRB, it is important that the will provisions ensure that the relevant legacies qualify, and that the scope is clearly limited. For example, if the property is left to a discretionary trust, the RNRB will not be available, even if the only beneficiaries of the trust are the testator's children.

A typical grandparental settlement like "to such of my grandchildren as reach 21" will not qualify if the grandchildren are minors at the date of the testator’s death, because it is a relevant property trust. To secure the RNRB, the grandparents would need to opt for a bare trust or at least an IPDI trust. Remember that 18-to-25 trusts and BMTs can only be created by parents.

What of existing trust interests?

A RNRB will be available if the deceased is treated as owning the property at the time of death. This means that the residence may be held in trust for the deceased (i.e. the relevant trust must either be an IPDI or a disabled trust), and on his or her death a lineal descendant inherits the property under the terms of the trust.

What if the property is given away during lifetime?

While the RNRB is only relevant to the estate on death, certain lifetime gifts are relevant to its availability on death. For example, if a property is given to children (or to a trust) during lifetime but the donor/settlor remains in rent-free occupation and the new owners do not move in, this will be a gift with reservation.

Notably, where property which has been gifted during lifetime remains in the donor's estate as property subject to a reservation, that property is capable of qualifying for the RNRB. However, the RNRB will be available in such cases only where the original gift was an outright gift made to lineal descendants (or their spouses/civil partners) as in such cases the property is deemed to be inherited by the donee(s). A gift to a trust, such as a 'probate trust,' mentioned above, would not qualify for this treatment.

RECALCULATE POTENTIAL IHT AFTER THE PROPOSED LIFETIME GIFTS/REINVESTMENT/WILL UPDATE

The resultant figure should be a good reason for the client to accept the recommendations for the suggested IHT mitigation plan. Needless to say, to the extent that the IHT liability cannot be avoided there is the option to take out a life policy in trust for the prospective beneficiaries.

Comment

The recent statistics about IHT receipts, as quoted above, may be a good starting point to a conversation about estate planning. Ideally, it should also be an intergenerational conversation: involving not only those typically in the market for IHT mitigation, but also their children and/or grandchildren. While the planning will mostly be undertaken by the parents/grandparents, it will be the children/grandchildren who will either gain or lose by any planning or the lack of it.