How can IHT be mitigated by those that do not want to give their assets away?
Anti-avoidance legislation has been put in place over the years making many IHT planning solutions unworkable. This is particularly the case where individuals wish to give away their wealth and yet maintain access.
The simplest way of mitigating inheritance tax is of course to give an asset away and survive 7 years. The dilemma is often that, although individuals are wealthy enough to have an IHT problem they may not be able to afford to make gifts, as they still require some form of access to the funds. There are however, two solutions which can be offered in conjunction with your Solicitor and preferably and Independent Financial Adviser:
- Loan Trust
- Discounted Gift Trust (DGT)
Both of these solutions provide access to ‘income’ and will either mitigate the potential inheritance tax liability immediately or in the long term.
Loan Trust
Loan Trusts ensure that any future inheritance tax liabilities on growth of the assets settled into them fall outside of an individual’s estate. This is suitable for people that want flexible access to capital.
The individual lends funds to the trustees for them to invest on behalf of the trust beneficiaries. The loan made is not a gift for IHT purposes as it remains an asset in the estate which can be called on at any time. However, any growth on the invested funds will be outside of the estate.
The following Table shows how effective a loan trust can be in mitigating a potential IHT liability:
|
On Creation Mary Loan Trust £ £ |
After Seven Years Mary Loan Trust £ £ |
Value of Bond Outstanding Loan Net Assets |
Nil 200,000 200,000 -200,000 200,000 Nil |
Nil 275,000 200,000 -200,000 200,000 75,000
|
In summary the Trustees investment in the example above has grown to £275,000 leaving £75,000 outside the estate and mitigating £30,000 in inheritance tax (£75,000 @ 40%). In the meantime Mary is still owed £200,000 by the Trustees and call on the repayment of this debt at anytime.
Discounted Gift Trust (DGT)
A DGT allows the settler to make a gift to a trust whilst retaining the absolute right to an income until death or the settled funds are exhausted.
The gift is a transfer of value for IHT purposes determined by the loss to the estate principle.
The value of the gift is calculated through an actuarial and underwriting process. Essentially this is the difference between the amount settled and the open market value of the right to ‘income.’ This value is what we call the discounted gift.
Another way of putting it is that the discounted gift is decided on the ongoing insurability of the individual. Basically, the younger and healthier a client is the greater the discount will be.
DGT Immediate IHT Saving |
||
John has an estate worth c. £352,000 (£252,000 house and £100,000 cash). His potential IHT liability is £16,000 (£352,000 - £312,000 @ 40%). John decides to make a gift of £80,000 to a DGT and chooses to receive an annual income of 5% pa. Following underwriting it is calculated that John will receive an initial discount of 53% (or £42,454) and should John survive 7 years the remaining 47% the total gift) will be fully outside the estate |
||
|
2008 £ |
|
House Cash |
|
£252,000 £20,000 |
£272,000 |
||
Gift Discount Annual Exemption Annual Exemption |
£80,000 -£42,454 -£3,000 -£3,000 |
|
Discounted Gift |
|
£31,546 |
Value of Estate |
|
£303,546 |
2008/ 09 Nil Rate Band |
|
£312,000 |
Taxable Estate |
|
Nil |
Summary
For those clients who have an estate that has a potential IHT liability, but cannot reduce its value as they need access to funds, Loan Trusts and DGTs provide suitable solutions. Whilst HMRC has accepted that these arrangements are valid for estate planning it is important to seek independent financial and legal advice when establishing an investment based trusts of this kind.