Financial planning: estate of the nation

Helen Ingleson, Head of Advice and Research, Rathbone Financial Planning

As more people are discovering, IHT, a tax on the transfer of assets which can be levied both in life and on death, can take a significant chunk out of a legacy. For most individuals born in the UK, the tax will be levied on their worldwide assets, which can make passing on legacies very complicated. But this need not be a source of worry. Estate planning offers many practical steps to ensure that your assets get passed on to who you want, when you want and tax-efficiently.
 
Successful estate planning will not just look at IHT efficiency. It will also take account of wider considerations, such as allowing you to maintain access to the income and capital you need while still alive, protecting assets from divorce or bankruptcy and providing for beneficiaries who may be very young or have a disability. 

When considering estate planning it is important to look across all your wealth, because making changes to one area will typically influence another. It is also important to recognise that the process will involve trade-offs to find the balance between what you want and what is possible. It is essential to adopt a methodical, step-by-step approach.

Step one: initial action

Initial action involves the quick wins that can have an immediate impact. As we mentioned in the previous article, nearly two thirds of adults do not have a will. This is a cornerstone of good estate planning. Remember, it allows you to direct who you would like assets to pass on to and can also include guardianship clauses setting out who should look after your children. Without either, the state decides.

Do not forget also to consider who would look after your affairs if you lost capacity to do so yourself. Capacity is typically considered an ‘old age’ issue, but who would have the legal right to make decisions on your behalf if you were in a serious car accident that resulted in life-changing injuries? An immediate step we can all take is to draft a power of attorney so you can choose who that would be.

Other quick wins include reviewing whether your life policies and pension death benefits are written into trust and reflect your wishes. Failure to check could mean your beneficiaries paying extra IHT or not receiving the proceeds at all.

Step two: using allowances and reliefs

The next measure to consider is the impact and use of IHT allowances and reliefs. Each of us has an IHT Nil-Rate Band (NRB) — the value of assets that can be bequeathed on death without being subject to tax. This typically stands at £325,000 per person, but where a person has previously suffered the loss of a spouse it is possible to have two allowances.

This year has seen the introduction of a Main Residence Nil-Rate Band (MRNRB), which can help if you wish to pass on your main residence to your children or grandchildren. Starting at £100,000, the MRNRB will rise in £25,000 increments each year until reaching £175,000 in 2020/2021. For house-owning couples with children this raises the prospect of these two allowances sheltering £1 million from IHT in 2020/2021. However, although they share similar names, the NRB and MRNRB work in different ways. It is recommended to revisit previous estate planning undertaken to ensure it remains completely effective.

‘Pension freedoms’ have also opened up the opportunity to pass on surplus pension wealth tax-efficiently, because assets within a pension have some IHT protection.

Step three: gifting

The next stage involves analysing your ability to reduce the size of your estate through gifting assets or money. You must not put your own financial security at risk by being too generous. Cash flow forecasts can identify what you can afford.

Broadly, gifts fall into one of two categories — exempt or non-exempt. Exemptions include gifts of up to £3,000 per donor year and gifts made on marriage. Similarly, donations made to charity, to political parties or for the benefit of the nation can be exempt if they meet specific conditions.

A frequently overlooked exemption applies where you make gifts out of surplus income which do not affect your standard of living. Documenting this properly is important. This exemption can allow you to give away significant amounts of money during your lifetime without incurring an IHT liability.

It is possible to make further gifts of capital and income to reduce the liability, but the IHT treatment of these non-exempt gifts must be thought through first. For example, providing you survive seven years, outright gifts are generally simpler and will not lead to a lifetime tax liability. They will, however, form part of your recipient’s estate for IHT and are vulnerable if the beneficiary is irresponsible or if they become bankrupt or divorced. In contrast, gifting into a trust adds complexity and costs more but can offer a number of advantages. It allows you to keep control over the assets and provides protection from bankruptcy and divorce. The assets do not form part of the beneficiary’s estate for IHT. In many cases, objectives may be met by using a balance of both.

Step four: insuring the liability

Ultimately, most of us will need to retain a reasonable amount of assets to maintain our lifestyle. This generally means that an IHT liability may still remain even after you have gifted as much as you can afford. The final action is therefore to consider using life assurance written into trust to meet that liability. A recipient of a gift may also wish to use insurance to pay a tax arising on a gift were you to die within seven years of it being made.

Finally, more esoteric options such as specialist investments that benefit from reliefs granted to investment in small business can be considered. However, as these carry a high degree of risk, appropriate advice is a must. 

Estate planning may be concerned with what happens on your death, but a significant part of it is focused on ensuring that you and your loved ones are looked after during life. It is an ongoing and complex process. Consider what you want to achieve, plan early and regularly review that plan with your adviser to ensure it remains on track.