Inheritance Tax

Having taken steps to minimise Inheritance Tax via Will planning, gifts and the use of Trusts there will often be a residual Inheritance Tax liability. In some cases this may be very substantial and it is certainly worthwhile considering some of the excellent Inheritance Tax plans offered by Insurance Companies.

Funding the liability using whole of life policies

Traditionally many Insurance Companies have offered last survivor whole of life plans written under trust for one's beneficiaries. The sum insured under the policy is paid free of Inheritance Tax and can be used to meet the Inheritance Tax liability on the Estate. The premiums are deemed to be a gift and may fall within the annual exemption (currently £3,000 per individual per annum), gifts from income or even be treated as potentially exempt transfers. These types of policy are most suitable for those in their early years of retirement and who are in good health. These plans are not normally available for those in poor health or above the age of 80 and in any event the premium required may be too expensive. The policies will pay the sum assured tax free to the beneficiaries upon the second death and this can be a very effective way of taking care of one's Inheritance Tax problem. It is important to take independent financial advice to obtain the most competitive terms as premiums can vary enormously.

Loan (and Gift) Schemes

A number of providers operate excellent loan trusts or gift and loan trusts which enable those individuals with a capital sum to invest and achieve the following:-

Growth on their savings outside of their Estate and Inheritance Tax free.
The ability to enjoy tax free income of 5% per annum for 20 years.
The ability to access on demand all or part of the remaining capital invested.

Initially a trust is established often with a small gift i.e. £3000. Any gift should be an outright gift to the beneficiaries which is held by the trust and invested by the trustees. The trustees are, of course, the investors so they have complete control over where the money is invested and who is the beneficiary or beneficiaries. Having established the trust an interest free loan of the remaining monies to be invested is then made to the trustees and once again this is invested by them. Normally the loan is repaid by way of monthly instalments often equal to 5% per annum which is tax free in the hands of the investor. All growth on the monies remaining in the trust belongs to the beneficiaries and is outside of the investors' estate for Inheritance Tax .

It is usual for the trustees to invest into an insurance bond and this can be held offshore to benefit from tax free growth during the plan's lifetime. Insurance companies offer a number of excellent funds including with profit funds enabling the trustees to choose from a wide range of investment mediums.

These plans are very suitable for those in their early stages of retirement who wish to maintain regular income from their capital and also wish to have the ability to access the monies invested if required. The Inheritance tax saving is achieved on the growth in the fund and can be very substantial after 10 or 15 years. Many insurance companies will also supply the trust wording although independent financial advice should be sought particularly with regard to the choice of plan and investment strategy.

Discounted Gift Scheme

This type of Scheme is suitable for individuals who are elderly or perhaps in poor health and who are less concerned with having immediate access to their capital but may require a regular income. Rather uniquely, these plans can achieve a very substantial reduction in the Inheritance Tax liability immediately the Scheme has been set up. Some other types of arrangement rely entirely upon the seven year potentially exempt transfer rules whereby no real saving is achieved in the first three years and the full saving is not achieved until after seven years.

Under a Discounted Gift Scheme, an individual makes a one off gift into a series of single premium investments which are designed to mature after one year, two years, three years, etc. During the period that the monies are invested, the death benefit will be subject to a trust and paid to the chosen beneficiaries. The underlying investment funds are normally held offshore to benefit from tax free growth during the term of the plan. Each year one investment will mature and will be returned to the investor as income. If however the investor does not require income the term of the investment may be extended.

Upon death the investments which have not matured will then be available to the beneficiaries. At the inception of the plan the Inland Revenue will estimate, based on mortality rates and the investor's health, the amount of the investment which is unlikely to be returned to the investor as maturities and will apply a discount to the value of the gift in a similar manner to an annuity.

In a recent example, an elderly widow made a gift of £235,000 into a discounted gift scheme for her son and daughter. Being aged 85 and in reasonable health, the Inland Revenue treated the gift for Inheritance Tax purposes as only £145,000. This created an immediate tax saving of 40% on £90,000 i.e. £36,000. The important point for the investor was that she retained the right to income each year and also as a trustee could if she wished alter the beneficiaries and have control of the investment strategy. The remainder of the gift i.e. £145,000 may also be tax free should she survive seven years.

This type of plan is without doubt the most attractive scheme available for elderly relatives who require income. Once again independent advice must be sought regarding the suitability and choice of the plan and investment strategy.

Retained Interest Trust

The Retained Interest Trust is a relatively simple Inheritance Tax plan which involves individuals making a gift to a trust for the benefit of selected beneficiaries. A portion of the gift will be earmarked as retained by the investor should he or she require access to capital. The remainder will be deemed to be an outright gift and subject to the normal rules regarding potentially exempt transfers (PETS). These are normally referred to as PETs! They occur where an individual makes a gift which would normally be taxable on death, but if he or she survives 7 years the gift becomes exempt. The value of the gift is also reduced between 3 and 7 years. Currently there is no limit on most gifts, excluding gifts to certain types of trust, which may qualify as PETs. All growth on the gifted part will be outside of the Estate for Inheritance Tax purposes. Growth on the retained part will be deemed as part of the Estate for Inheritance Tax. The monies are normally invested by the Trust into an offshore insurance bond from which 5% of the total amount invested can be withdrawn tax free for 20 years. Income withdrawn is deemed to be repaid from the retained part of the investment and any growth on this retained element. This plan can achieve very substantial tax savings after a period of 7 years and is particularly suitable for investments in excess of £500,000.

The above plans are not an exhaustive list of those offered by Insurance Companies but give a good indication of the types of schemes available. In all cases it is imperative that professional independent financial advice is sought from a firm specialising in Inheritance Tax structures.

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