Mitigating IHT – 3 strategies beyond the obvious

Even the name is a poor narrative in the UK. Let me explain.  International law distinguishes between an estate tax and an inheritance tax; an estate tax is assessed on the assets of the deceased, while an inheritance tax is assessed on the legacies received by the estate's beneficiaries. However, this distinction is not always observed; for example, the UK's ‘inheritance tax’ is a tax on the assets of the deceased, and strictly speaking is therefore an estate tax. Our close neighbours, including the Republic of Ireland, France and Spain, have true inheritance taxes, and the US’s estate tax, is just that. Of course, each system is nuanced with tax harmonization not even a fleeting dream, even within the EU.

In recognition of the complexity of the UK tax code, David Cameron in 2010 established the Office of Tax Simplification (OTS), now an independent office of Her Majesty’s Treasury (HMT). It was set up to advise the Government on simplifying the UK tax system. In 2015, examining all variants of UK personal taxation, IHT ranked 3rd out of 107 areas for ‘underlying complexity’, and the OTS subsequently offered reports dedicated to IHT for Government in 2018 and 2019.

With almost 90 reliefs and exemptions, there are, in fact, plenty of ways to plan to alleviate the burden of this tax, and in this article I’ll pick up on three powerful planning opportunities.

The ‘reuseable’ nil rate band

I’m sure we, and some of our clients, would recognise the nil rate band (NRB), transferrable NRB, residence NRB and transferrable residence NRB, but how about the notion of the reuseable NRB? The residence NRB is useable on death, as is the transferrable NRB, although only on the second death (for married couple or civil partners). However, the straightforward NRB can be used during the lifetime, as well as on death. A transfer to a trust or outright gift (chargeable lifetime transfers and potentially exempt transfers) normally fall out of account after seven years, freeing up the NRB that they represent up until that time, meaning after that time, the NRB can be used again, in lifetime or upon death. This means that someone in their 50s, of good health, could easily expect to use the NRB at least five times, in today's term removing ￡1.625 million plus from their estate, not to mention the residence NRB. As well as this, making lifetime gifts could also keep the estate below the important ￡2 million threshold, meaning the residential NRB isn’t tapered away, not to mention that the growth on those gifts is outside of the estate of the donor too. 

Deeds of variation (into trust)

It’s well known in the profession that a deed of variation by the recipient of a will, made within two years of the death of the testator, and meeting some other basic conditions, can allow for the gift to be considered to be that of the deceased, rather than the recipient. But it can have better value than this obvious ‘generation skipping’. If the wealth inherited is instead varied into a discretionary trust, then according to the trustees’ decisions, the original beneficiary can still enjoy the benefits, as they can be included in the class of possible beneficiaries, without there being a gift with reservation. Furthermore, amounts could be provided to them as a loan from the trust, repayable upon death, which could reduce their otherwise chargeable estate even further. Bonds are often the perfect vehicle, from a trust accounting perspective, particularly with discretionary trusts.

Asset freezing

Whilst this might sound like an experiment in a geology text book, in financial planning terms this can refer to planning to prevent growth on the estate from increasing ones’ exposure to IHT. Whilst clients will often baulk at giving something away, and foregoing future access, they are often more amenable to retaining control and access to what they have now, but giving the growth away in a controlled manner. The Quilter International Loan Trust does exactly that. 

Here, the settlor lends money to trustees who then invest in a bond. The loan is repayable upon demand, and on death. Regular pre-ordained repayments may be perceived as income in the eyes of most clients, but could be tax efficient withdrawals or repayment of discreet segments.

The effect of this is that the original capital is always available to the settlor, and the growth is created outside the estate. This is often valued by younger clients, who don’t want at their age to tie wealth up, and those planning with large premiums. This is because a discretionary loan trust is by definition established by a loan to a trust, not a gift. This means that any size loan, including above the NRB, does not create an entry charge of 20%, and if a series of these is established over consecutive days, periodic and exit charges may also be manageable courtesy of what is often referred to as the ‘Rysaffe principle’.  The growth can be appointed out to a wide class of beneficiaries, at the trustees’ discretion, including during the settlor’s lifetime if appropriate.

To consider how effective this strategy might be, it’s worth contemplating possible growth rates and life expectancy. For example, a British born male, standard health for his age, at 55 might have a 30 year life expectancy. If the premium was ￡500k, and the growth was annualized at 5% net of charges, at the date of death, more than 75% of the plan value would free from IHT, and an even greater proportion if withdrawals had been made.

As you can see, there are lots of things you can do to help your clients preserve their wealth, and Quilter International can help.

Visit Quilter International’s Technical Centre for more information on inheritance tax.

If you enjoyed my post, please click the thumbs up icon, leave a comment and share it with your network. Thanks.

The information provided in this article is not intended to offer advice and is for financial advisers only.

It is based on Quilter International's interpretation of the relevant law and is correct at the date this blog was published. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this blog.