Freezing the Nil Rate Band heats up the need to plan

June 1st 2010

ONE – MAKE USE OF THOSE EXEMPTIONS

The primary starting point for anyone who is wishing to carry out Inheritance Tax (IHT) planning is to use your exemptions. The key is to remember that there are a number of inheritance tax exemptions which clients can continue to take advantage of , none of which have been affected in any way. The first step is therefore to make maximum use of available reliefs and exemptions. The most common ones being:

 • Annual exemption – each individual can give away £3,000 each year, and use the previous year’s exemption if not already used.

 

• Small gifts exemption – up to £250 can be given to any number of individuals.

 

• Normal expenditure out of income – gifts can be made out of surplus income.

 

Exemptions also apply to gifts on the occasion of a marriage and gifts to charities and community amateur sports clubs. Planning in this area is often overlooked or ignored with few clients using

such exemptions to the full potential. Although, where there is an immediate inheritance tax saving to be made with such simple planning, clients should not forget these!

 

TWO – CONSIDER LIFE TIME PLANNING

 

In some cases it may be possible for you to make more substantial lifetime gifts, whether outright to another individual or by executing a trust. The current regime for outright gifts is indeed very favourable, giving significant scope for lifetime planning. Outright gifts are ‘potentially exempt transfers’ (PETs) for inheritance tax purposes, meaning that no tax is paid on the gifted amount, or on any increase in value if the donor survives for the required seven-year period. Also, there is no limitation on such gifts or on the amounts which can be gifted. So provided the donor is in reasonable health and is happy to make such gifts, substantial inheritance tax savings can be made. The same inheritance tax treatment also applies where you wish to execute a bare (absolute) trust, which in turn will also fall out of account provided the settler survives seven years from the date the trust is created.

 

Outright gifts to another individual, provides for the more simplistic type of planning, not only by taking advantage of the potentially exempt transfer regime but also because very little administration requirements need to be fulfilled. However, outright gifts still may not be a suitable option for you, if you wish to retain maximum control or where a bare trust is concerned, do not wish your beneficiaries to receive the trust assets at 18. It is for this reason that you might miss the chance to save tax through lifetime gifts because you are reluctant to lose control. But should this be a barrier? It is possible for you to set up lifetime trusts without losing control. The trust will allow for the ultimate destination of assets to be determined under its terms in accordance with your wishes.

 

Today most forms of trusts where you maintain control of the assets are taxed as relevant property trusts and so are subject to the discretionary trust tax regime. Because the trust fund does not vest in anyone’s estate for inheritance tax purposes, associated inheritance tax charges apply on creation, when capital is appointed out of trust and on each tenth year anniversary. These are more commonly known as an entry, exit and periodic charge.

 

THREE – DISCRETIONARY WILL TRUST PLANNING

 

On 9 October 2007, the Chancellor introduced the concept of a transferable nil rate band which at the time was well received in the industry. The idea being that where a spouse/civil partner died leaving assets to the survivor, the executors would have two years from the date of the second death to make a claim to use the unused percentage of the first spouse’s/civil partner’s nil rate band. This unused percentage is based on the nil rate band applicable at the time of second death. This provides for the increase in the nil rate band over time. With the nil rate band being frozen for the next four years, you could consider whether discretionary will trust planning is a viable option, as assets would be expected to grow at a faster rate than the frozen nil rate band.

 

Summary of the benefits to be obtained by will trust planning:

 

It provides certainty that the planning is in place and will equally be safeguarded against third party claims that could arise on the surviving spouse’s estate, e.g. on bankruptcy or remarriage. This type of planning may also be suitable for those of you who are on your second (or subsequent) marriage, by providing peace of mind as you can be sure that trustees will be able to make appointments in favour of your chosen beneficiaries. The value of the trust fund does not vest in anyone’s estate for inheritance tax purposes, which means that beneficiaries can benefit from assets without increasing their own inheritance tax estate.

 

It provides the potential inheritance tax savings illustrated above. Discretionary will trust planning also eliminates the need to make a ‘transferable nil rate band claim’ by the personal representatives, which reduces the administration aspects for them.

 

FOUR – DEEDS OF VARIATION

 

Where property is inherited, whether under a will, under the intestacy rules, or by survivorship, it is possible to redirect the inheritance to achieve inheritance tax savings by using a deed of variation. There was nothing announced in the 2010 Budget to bring this type of planning to an end. However, to achieve the desired outcome, this planning must be carried out within two years from the date of death by the person who has inherited the asset(s) and the property must have been included in the deceased’s estate at the date of death. Ordinarily the inherited assets will accumulate with the taxable estate of the receiving beneficiary who may not want or need the inheritance. Instead of choosing to make a gift of the inheritance (which would either be treated as a potentially exempt transfer or a chargeable lifetime transfer),you can take advantage of the deed of variation option to make an immediate inheritance tax saving on your own estate. For a variation to be valid the following conditions must be satisfied:

 

• the variation must be in writing (usually by deed)

• it must be made by the person or persons who would have benefited from the original gift

• it must be made within 2 years of the death

 

• the document must contain a statement that the relevant legislation (s142 IHTA 1984) is intended to apply.

 

For inheritance tax purposes, the variation is treated as though it had been made by the deceased person and not by the person entering into the variation. In addition there is no requirement to vary the entire amount of the inheritance enabling you to choose to vary only part of it. It is possible to vary an amount directly to an individual or to a trust. So even in cases where the beneficiary is financially secure, variations to trusts should always be considered as an option, especially as the varying person can be named as a beneficiary, providing access to the varied amount. In essence, deed of variation planning is unique and produces an outcome that cannot be matched by other arrangements.

 

FIVE – INVEST IN INHERITANCE TAX FREE ASSETS!

 

Finally, investing in assets which qualify for business property relief or agricultural property relief could provide you with substantial IHT savings. Obviously you would need to consider whether this is something which is desirable or even appropriate for you, as with any type of investment. The maximum relief available for both business property relief and agricultural property relief can be 100% of the value of qualifying assets. Provided the qualifying assets have been held for a minimum of 2 years their value will be left out of account when computing the taxable value of an individual’s estate for inheritance tax purposes. In some circumstances relief can be reduced so you should always seek advice to quantify if such reliefs would be available to you. And for those of you who enjoy a bit of risky business, consideration could be made to investing in an Enterprise Investment Scheme or in AIM (Alternative Investment Market) shares in companies carrying out a qualifying trade. Once you have held the shares for at least two years the shares would normally qualify for 100% business property relief.