Once in a lifetime IHT planning opportunity

Anecdotal evidence seems to indicate that few advisers are working on Inheritance Tax mitigation at the present time and yet in reality the credit crunch has generated the most ideal environment for such planning for many years.  Whilst it is true that the transferable Nil Rate Band has taken a number of more modestly wealthy individuals out of the IHT trap, the number of taxpayers likely to pay this tax still appears to be substantial.  Of course, advisers are saying that their wealthy clients are more taken up with repairing their personal balance sheets (after the hits they have taken from the credit crunch and stock market rout) than they are with mitigating tax.  This is, however, a foolish approach since the credit crunch and its impact is temporary whilst the prospect of gifting one’s hard earned wealth to the Government is permanent.

I have been looking at house prices in London to get an idea of the temporary impact of the wealth destructive effects of the mortgage famine (which I believe is the real culprit in house price falls).  Looking at terraced houses, which represent the modest living accommodation of average Londoners, it seems that those living in suburbs like Camden, Fulham and Islington (even after recent substantial falls in values) still have properties worth in excess of a couple’s Nil Rate Band.  Meanwhile a couple living in Wandsworth have seen their terraced house fall from £620,000 down to £500,000.

 The other disincentive when considering IHT planning has been the dramatic falls in equity values.  During 2008 a massive 31% was wiped off the (FTSE 100) value of shares, a reversal not seen in any other year since the FTSE 100 was launched in 1984.

 These falls in personal asset values beg the question as to whether it is correct that taxpayers have become distracted from considering their potential IHT positions.  In my submission, whilst I understand the current concerns about rebuilding assets, there are very many reasons why taxpayers should be focusing on IHT mitigation at this very moment.  The main three, which I will cover individually are: (1) the seven year clock necessary to remove assets from one’s estate should be started as soon as possible; (2) the depressed value of personal assets at this time offers a ‘once in a lifetime’ opportunity to supercharge any such planning, and; (3) the availability of highly flexible schemes based on both unit trust portfolios and bonds means there is no reason to not put IHT mitigation in place as an additional benefit of normal portfolio planning.

The Seven Year Clock
Recent research (from WAY Group) indicates that taxpayers adopting IHT mitigation are doing so much later than they perhaps should to get best value from the seven year period it takes for asset transfers to fall out of one’s estate.  Men typically start planning at age 69 and women at age 72.  That leaves the average person with only one complete seven year period between starting IHT planning and when they are likely to die.  So the earlier one starts IHT planning the better to make sure one survives the seven year run-off period or even to enjoy more than one set of gifts (more than one seven year period).

Once in a lifetime opportunity
There is little doubt that today is a great time to be doing one’s IHT planning.  Why?  Because:

•         Proportionately one can remove far more from one’s estate today than a year ago, and probably in a year’s time, because of depressed values. Transfer now whilst prices are cheap.
•        There will inevitably be a recovery and assets will substantially increase in value.  Whilst nobody really believes the Halifax statistics for house price rises in January it does give some indication that there will soon be a bottom and then a recovery.  This is linked far more to the availability of mortgages (which disappeared for several months in 2008 and under Government pressure are now reappearing) than to sentiment.
•        We have seen the early green shoots of stockmarket recovery since the lows of last year and no-one should doubt the potential for a worthwhile recovery this year.
•        By moving assets into trust now, the resulting change in beneficial ownership will trigger a Capital Gains Tax (CGT) point, BUT at current depressed levels very few people will have to pay any CGT.
•         Any recovery in values, once assets are transferred, will conveniently occur outside the donor’s estate thereby saving substantial IHT on that extra value (IHT savings at 40% far outweigh any future CGT at only 18% on gains above the allowance).

With Government finances in a mess there are unlikely to be further cuts in IHT for the foreseeable future, regardless of which political party is in Government.  So there is an extremely strong case for those potentially liable to IHT to get the seven year clock ticking.

 No reason not to plan
Until a few years ago IHT planning involved putting on a financial straitjacket whereby putting assets beyond the reach of the tax man normally involved putting them beyond one’s own reach (other than possibly a fixed future ‘income’).  In addition, most traditional IHT arrangements were based on life assurance bonds and their often inconvenient attendant Income Tax status. 

 Those restrictive days have long gone and the IHT mitigation market has moved on very much in line with other contemporary developments in the investment management arena.  It is now possible to engage highly flexible trust arrangements in which trustees have extensive flexibility in passing benefits to the donor and/or beneficiaries as dictated by circumstances rather than simply by prescription.  In addition these arrangements can now contain the kind of managed portfolios investors would have held, in any case, had they not been planning for IHT.  It is now even possible for IHT-shielded portfolios to be managed on the most contemporary of investment platforms.

 The trust flexibility and investment options available today mean that the only argument for not placing an IHT mitigation trust around a client’s portfolio is the marginal extra cost of doing so which, even with trustee fees, normally works out at less than 1% per annum.

Advisers would be well advised to look afresh at contemporary IHT planning which is no longer a ‘magnum opus’ and simply represents a best practice ‘add-on’ for any portfolios managed on behalf of wealthy clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 13th February, 2009 |
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A tale of IHT mitigation

John and Frances Greening are facing a major dilemma regarding the death of Frances’ widowed mother in January 2008. Frances is the sole beneficiary of her mother’s Will and she was left a substantial inheritance which has unfortunately fallen in value very dramatically in the intervening period. John and Frances have been working their way through the probate process and suddenly realise that they are caught out by the credit crunch from settling the estate in the most effective manner. They are having difficulty raising funds to pay the Inheritance Tax in order to achieve the very probate which will allow them to sell assets to pay the tax. The assets in question have fallen so much in value that the effective rate of tax they could finish up having to pay is much higher than the 40% normally payable upon death. Frances’ father died nine years ago and utilised the whole of his Nil Rate Band.

There are three different problems here which combined are putting this couple in a very difficult position indeed. The challenges are:

• Mum lived in the suburbs of London in a house valued (at the date of death) at about £1.3 million. In addition she had other, financial, assets totalling a further £0.4 million. Based on a Nil Rate Band of £300,000 (as at January 2008) this would incur IHT of £560,000. So they have to find a lot of cash to pay the IHT in order to be able obtain probate to sell any assets.
• The value of the house has probably fallen by some 30% since her death and the value of the share portfolio (which was weighted towards banks with a generous exposure to builders and mining stocks) has fallen by nearer 50%. The theoretical values are therefore now £910,000 for the house and £200,000 for the shares. The house is unlikely to be saleable since similar properties in her area are just not moving. The IHT based on these lower values would be £324,000 – a huge £236,000 less than on the death values.
• There is an HMRC concession whereby falling asset prices can be re-based for probate purposes but only if they are sold by the executors within a specified period after death – 48 months for property and a challenging 12 months for other assets. To sell, the executors must have obtained probate. This is only achievable if the full tax is paid in advance and a re-base claim then made later when the assets are sold at lower prices.

The Greening’s have less than 2 months to sell the shares to establish a lower re-base value. If they manage to achieve this they will probably be well advised to re-invest any proceeds in Frances’ name straight away, to make sure they do not miss any subsequent recovery. But this assumes that they achieve probate and to do so they must pay any tax due. With Capital Gains Tax now at 18% it is better for any recovery to happen in Frances’ name rather than with the executors where any recovery will fix the IHT on the gain at 40%.

Fortunately, there is also the property instalments concession which they can use to avoid paying the full tax on Mum’s house immediately. They will have to pay 10% of any tax due to achieve probate and can then pay the remainder in another nine annual instalments with interest. This means that they can take their time selling the property and to claim any re-basing (if the house does not climb back above January’s value) so long as they sell by January 2012.

So what does this now all look like in terms of what they must do before January to achieve the optimum results – remembering that probate can take some time even once the application is in and the tax is paid? They will have to pay the full tax on the ‘other assets’ and the first instalment of tax on the property (plus a little bit of interest which becomes payable from 6 months after the date of death) before they can have access to the shares to sell them before the 12 months is up. They must work very fast to get the probate application in to make sure they get probate in time.

The calculation looks something like this:
Total Assets (£1.7m) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (the £560,000 mentioned above). This gives a marginal rate of IHT of 32.94%. This rate is applied to the separate assets, so they will have to pay £131,765 on the ‘other assets’ (32.94% of £0.4m) and £428,235 on the house (32.94% on the £1.3m) but need only pay 10% of this immediately. So to obtain probate they must submit the necessary forms and make a payment of tax on account of £174,588 (£131,765 plus £42,823).
They have to find this cash from somewhere and in the present climate that will not necessarily be easy because there are no assets available to charge to a bank (until after probate). Assuming they can raise this cash, obtain probate in time and sell the shares before the first anniversary of Mum’s death, then they can ask for the share valuations to be re-based onto an actual basis. They will then be able to obtain a partial refund from HMRC following a new calculation, as well as being able to repay the bridging finance from the share proceeds.

The new calculations will then look like this:
Total Assets (£1.5m now that the share values have been re-based) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (£480,000). This now gives a marginal rate of IHT of 32%. This rate is applied to the separate assets, so they should have paid £64,000 on the ‘other assets’ (32% of £0.2m) and £416,000 on the house (32% on the £1.3m) of which only 10% was payable immediately. So their initial tax bill should have been £105,600 and not the £174,588 they actually had to pay on account. So they should receive a refund of almost £69,000 at that point.

These potential calculations are repeated all over again if and when Mum’s house is sold for less than the original probate value. Again, there is some sense in pursuing this because John and Frances will receive an IHT refund at 40% on any reduction whilst only suffering CGT at 18% were they to reinvest and enjoy an increase in property prices.

This whole scenario simply underlines the benefit of removing assets from one’s chargeable estate early enough to avoid all of these probate challenges, quite apart from the general benefits of avoiding as much of this heinous tax as possible.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: IHT Mitigation |
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IHT and the Glenrothes effect

Labour’s surprise victory in the Glenrothes by-election (7th November 2008) has rekindled that party’s hopes of achieving re-election sometime in 2010. The reasons for the unexpected vote of confidence in Labour probably include Gordon Brown’s new reputation as financial crisis Superman as well as the apparent policy vacuum from Cameron and his front bench colleagues in relation to the current banking and economic chaos.

There has recently been some question about the future of Inheritance Tax (IHT) planning for Mr and Mrs Average. For a brief interlude the combination of falling house prices, falling stockmarket values and the promise of a couple’s £2 million Nil Rate Band from the Tories seemed to make IHT planning for all but the very wealthy somewhat less urgent.

This view is completely misplaced and has to be challenged because taxpayers need very little encouragement to be completely complacent about a tax which they will never suffer but which brings great difficulty to the next generation. An interesting and extremely difficult by-product of the recent fall in asset values, particularly house prices, is that many taxpayers that have died over the last year or two left taxable assets which have subsequently fallen dramatically in value before they were able to be sold to pay the tax.

Imagine someone having died early this year with a sizeable share portfolio focused on banks, builders and mining companies. They may be required to pay 40% tax on assets which have subsequently fallen in value by 90%. To put that into context the tax on an investment portfolio of, say, £300,000 might be £120,000 (at the full 40% assuming their Nil Rate Band was exhausted elsewhere) and yet the related portfolio may have fallen to only £30,000 in value after the dramatic market falls of the last few months. How can you realise £120,000 of tax from a portfolio worth only £30,000 – what a horrendous side effect of the recent market debacle.

This has been exacerbated for tax on properties where beneficiaries are faced with a market which has not only tumbled but in many cases has become completely static so that properties cannot be sold at all. In both of these cases there is an HMRC concession to re-base the value but it requires a sale of the assets in question by the executors within a set time period (12 months for shares) and only after the full tax has been paid to facilitate probate – so a major cash flow challenge especially in the current banking climate.

This whole new scenario is an added incentive to make sure that assets are transferred outside a taxpayer’s estate more than seven years before their demise to remove the relevance of pre and post death values. If the whole value is beyond the reach of the taxman then no tax will have to be found and therefore there will be no forced sale of assets.

So what chance is there that IHT is a thing of the past for most of us? Shadow Chancellor George Osborne was recently compromised into a confirmation of the impact of Alistair Darling’s moves on transferability of Nil Rate Bands between spouses and civil partners. Transferability combined with the Tories’ Autumn 2007.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: Glenrothes by-election, IHT Mitigation |
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