Welcome to our “Financial Planning Insights” series, where our team delves into various concepts and products that may be pertinent to you. Each month, our Financial Planners unpack how different Products operate, who they can benefit, and provide practical examples to illustrate their applications.

This month, our Financial Planning Director, Thomas Johnson, provides an in-depth exploration of Inheritance Tax Planning (IHT) options, focusing on how Life Assurance and Trusts can effectively mitigate potential IHT liabilities.

Understanding Inheritance Tax (IHT)

Inheritance Tax (IHT) is a tax levied on the estate—comprising property, money, and possessions—of an individual who has passed away. Here are key points to grasp about IHT:

• Nil-Rate Band: Currently set at £325,000, the nil-rate band establishes the threshold below which no IHT is payable.
• Standard Rate: Estates exceeding the nil-rate band are typically taxed at a rate of 40%. However, there are exemptions and reliefs available that can reduce this liability.
• Spouse or Civil Partner Exemption: Transfers of assets between spouses or civil partners are usually exempt from IHT.

Gifting into Trusts to Reduce IHT

Gifting assets into Trust can be a strategic method to diminish IHT liability. The following Discretionary Trusts are commonly utilised for this purpose:

• Lifestyle Trusts: The settlor transfers funds into the Trust (usually up to £325,000) and retains the right to receive 5% of the initial capital annually, tax-free. This income can be deferred to subsequent years if not immediately required.
• Discounted Gift Trusts: Here, the settlor gifts funds into the Trust (typically up to £325,000), with the value discounted based on their age and health. The discounted amount is immediately excluded from the settlor’s estate, while the settlor receives a fixed monthly income that remains unalterable.
• Loan Trusts: Funds are lent by the settlor to the Trust, remaining part of their estate. However, any growth from the gift is immediately excluded from the estate.

Holding assets in Trust facilitates a smoother intergenerational transfer and bypasses probate complexities.

Life Cover Options for IHT Planning

Life cover can play a crucial role in IHT planning by covering anticipated tax liabilities. Commonly used policies include:

• Whole of Life Cover: Provides coverage for an individual’s entire lifetime, guaranteeing a payout upon death. Due to this assurance, it tends to be more expensive.
• Level Term Assurance: Offers life cover up to a maximum age of 90.
• Gift Inter Vivos: Provides life cover for seven years following a gift, reducing over time as taper relief applies.
• Increasing Term Assurance: The sum assured on the policy grows annually, making it suitable if your expected IHT liability is projected to increase.

Case Study

We often work with clients who have a high inheritance tax bill, and they often believe that it would be too complex to be able to fully mitigate this, or that the cost of ‘life cover’ would be too much. We have a 7-step plan that we use and based upon a couple having a potential IHT Bill of £1m, and they have investable assets of £2m, our IHT planning advice could be as follows:

1. Check if the clients have any relevant earnings, If so, they are able to invest into Pension which will then be outside of their estate
2. Place £650k into Lifestyle Trusts now
3. Place £1.3m into Loan Trusts now
4. In 7 Years time, they could assign £325,000 each from their Loan Trust into their Lifestyle Trust
5. In 14 years, time, they could assign £325,000 each from their Loan Trust into Lifestyle Trust
6. In 21 Years, time, assign remaining the Loans into the Lifestyle Trusts
7. Take out £1m of life cover now, reducing by £260,000 every 7 years

Their potential IHT bill is covered now & potential IHT liability is mitigated against for the next 21/28 years and all growth is outside of their Estate straight away, saving them in excess of £1m.

Furthermore, life cover typically gets more expensive the older a client becomes, through careful Financial Planning, our clients see their life insurance premiums reduce as they get older, and more of their assets can be passed on their loved ones.

The Importance of Early Inheritance Tax Planning

Early IHT planning with your Financial Adviser is crucial. If you have concerns or wish to discuss your IHT position, contact us at 01484 534431 for a consultation. Appropriate planning can save significant amounts in potential IHT liabilities.

Please note, the information provided is intended as a summary of planning avenues and is based on current UK taxation and legislation. It does not constitute financial advice. For a comprehensive overview of IHT regulations and exemptions, you can refer to the HMRC Inheritance Tax Guide.