6th May 2023
general
But if you have worked hard to build up wealth, saving tax is unlikely to be your only goal. You probably also want to preserve the assets for your family, and to protect them as far as possible from bad luck and poor judgement. There is no one ideal solution, but there are several options that can help to protect wealth throughout the generations.
Make a Will
The first step is to make your will. This means that your assets can be distributed according to your wishes, and that someone you trust will administer your estate. The rules of intestacy are unlikely to work in your family’s favour, particularly if you have a large estate or complex family situation.
You should also review your will regularly. Births, marriages, deaths, and divorces can all impact your wishes, as well as the legality of your will. It’s worth taking legal advice to ensure that your will is effective and complies with the law.
A will has its limitations, as you can only specify what should happen on your death. You can’t influence what your beneficiaries do with the money thereafter or what happens when they die. They may overspend, invest poorly, or lose some of the money to a divorce. If you pass your estate to a spouse and they remarry, the assets could end up out of your family’s hands altogether.
Setting up trusts can help to mitigate some of these risks.
Consider a Trust
You can set up a discretionary trust as part of your will, with your spouse, children, and wider family as potential beneficiaries. This means that no one individual will own the assets, and that they will be under the care of trustees. The assets can’t be touched in the event of bankruptcy or part of a divorce settlement. Multiple generations can benefit from the trust.
There is no limit to the value of trust that you can set up, but there are tax implications for exceeding the nil rate band (£325,000 for an individual and £650,000 for a couple). The settlement is not exempt from IHT as a transfer to a spouse would be, even if one of the beneficiaries is your spouse. Additionally, the trust may face periodic and exit charges throughout its lifetime if it is valued over the nil rate band.
You can also set up discretionary trusts during your lifetime. It’s possible to move substantial sums out of your estate over the years and ring-fence the money for your beneficiaries. You can transfer £325,000 into trust (£650,000 for a married couple) without immediate IHT implications. Gifts above this level are subject to an entry charge of 20% on the excess as well as the periodic and exit charges mentioned above.
If you die within seven years, the gift is added back into your estate, using up your nil rate band and increasing the IHT liability on your estate. Additionally, any gifts into trust during the previous seven years are added back into the estate, which means potentially looking back up to 14 years. Leaving a seven year gap between gifts and keeping the value under the nil rate band can help to minimise the tax implications.
Bare trusts are another option, but as beneficiaries can’t be changed, they are more akin to outright gifts in terms of control and taxation.
Make Gifts
As well as making gifts into trust, you can make outright gifts.
You can give away up to £3,000 each tax year (£6,000 for a couple), which is immediately outside your estate. Additionally, if you have genuine surplus income from employment, dividends, rental, or a pension, you can make regular gifts of any amount. Larger gifts are outside your estate after seven years.
Of course, you will give up access and control of the money, but you can decide how, when, and to whom the money should be distributed during your lifetime. Outright gifts also avoid the complexity of trusts.
What if You Need Access to the Money?
To be effective for IHT, a gift to an individual or a trust must be irrevocable, leaving you with no access to the money.
If you need to retain access to income or capital, for you or your spouse, some specific types of trust may be suitable.
For example a discounted gift trust is structured in two parts – a gift into trust and a pot designated to provide you with an income. This offers an immediate reduction in the value of your estate, a full exemption after seven years, and a regular income. Investment growth is also outside your estate.
Loan trusts are similar, but more flexible. Your initial investment is considered a loan, which remains inside your estate. Investment growth accumulates outside your estate. You can reduce the value of the loan (and therefore your IHT liability) by writing it off over a period of years (which is subject to the gifting rules outlined above) or by withdrawing money and spending it.
If you need to provide some security for your spouse, an interest in possession trust could offer a solution. This allows your spouse (or any other beneficiary) to receive a lifetime income from the assets, while preserving the capital for the other beneficiaries (e.g. your children) on their death.
Usually, the more tax-efficient the option, the less flexible it is. It’s a good idea to take advice if you are considering any kind of trust.
Family Investment Companies
For larger estates which have exhausted the options in terms of trust planning, a family investment company may offer another solution.
This means a company is set up to invest in assets, for example, shares or property. Shares in the company can be allocated to family members, with their holdings gradually increased. The original owner’s estate is reduced, but they still have control over the company and a potential income.
A controlling stake is worth more than a minority stake as it offers more benefit. The difference between gifting a 49% holding and a 51% holding is significantly more than 2% in terms of valuing an estate.
Unlike trading companies, investment companies do not benefit from business relief. Any IHT reduction comes from managing the allocation of the shares within the usual gifting rules. More shares can be issued, allowing other family members to join the company later.
This is a complex area, and tax advice is recommended.
Pension Funds
Pensions are designed to provide retirement benefits, but they are equally useful as an estate planning tool. There are limitations on how much you can pay in and build up, but your pension fund can complement your other estate planning strategies.
Pensions can be passed on free of tax if you die before age 75. After age 75, beneficiaries only pay income tax (at their marginal rate) if they withdraw money. They can also pass on the fund to their own beneficiaries.
Estates can be complex, particularly when it comes to inter-generational planning. It’s worth taking advice to determine the best strategy for you.
Please don’t hesitate to contact a member of the team if you would like to find out more about estate planning.
