The Government may be clamping down on traditional tax planning but there
are other ways to reduce Inheritance Tax
Making a gift of property, into a lifetime trust or via a will, has become a
common way for many married couples to reduce their potential inheritance
tax liability. But changes to the regulations surrounding estate planning
now means many of the established forms may no longer work but there are
other simpler ways to plan.
Rising property prices have meant more people are likely to be liable for
Inheritance Tax. In fact, last year there were 2.4 million homes which exceeded the
From December 5, when the Civil Partners Inheritance Protection Act comes into force, more
property owners will be able to take advantage of planning for Inheritance
for the first time. The Act allows single sex couples to have the same
rights and exemptions as married couples. This includes Inheritance Tax.
As the market for property planning is getting bigger, it is important to be
familiar with the current planning methods and the issues affecting them.
It used to be a simple process to remove property from the estate but as the
Government clamps down on traditional planning, it is not that easy any
more. With the help of a solicitor, some advisers would suggest the use of
lifetime trusts to make a gift of a person's share in a property. But the
introduction of new regulations, such as the pre-owned asset tax, have made
effective lifetime planning with property much more difficult.
Clients were able to gift away their property effectively for tax to a
chosen beneficiary and still remain living in it. The Revenue changed this
in 1986, with the introduction of the gift with reservation rule which meant
if the client retained an interest in an asset, it would be treated wholly
in their estate for Inheritance Tax purposes. Of course, it did not take long before tax
planners found ways round this, with such things like inter spousal trusts.
The Revenue reacted to this by introducing Poat. This is charged on any gift
that is not a GWR but where the settlor still has a beneficial interest. It
applies to all gifts made since March 17, 1986 and is currently charged at
an annual rate of 5 per cent of value. As can no doubt be seen already,
either the GWR or Poat rules will usually catch any gift of the property
where the donor retains occupation.
To get the best out of this situation, the donor can pay a full market rent
to the donee, live in joint occupation with the donee but have no benefit,
or simply move out. Slightly harsh some might say - pay a tax (whether Poat
or Inheritance Tax), pay a rent or get out.
There are plenty of advisers who are already aware of these issues, so have
chosen to look at will planning instead. The first thing to do is to change
the owners Inheritance Protection of the property to tenants in common. This gives each person
an absolute share of the property rather than jointly owning all the
property. The wills are then amended to leave each person's share to their
chosen beneficiaries, in most cases their children.
The beneficiary will receive the legacy on the death of the donor which then
gives them outright owners Inheritance Protection of that share in the property. This means the
beneficiary could then move in, or even force a sale which could result in
the widow/widower having to find somewhere new to live.
This has often led to a condition being written into the will which states
the property cannot be sold during the widow/widowers lifetime, or that the
beneficiary cannot take occupancy during this period. This though, is likely
to create an interest in possession for the widow/widower in the donor's share
of the property. This in turn means the full value of the property is in the widow/widowers estate for
Inheritance Tax purposes which negates the planning.
Another idea is to leave the share of the property to a discretionary will
trust but similar issues to those mentioned earlier still apply.
A simple but wholly effective method already exists - whole of life
planning. Whole of life plans have never been more suited as a viable tool
for estate planning. The plan can be used to cover all or part of the
client's Inheritance Tax liability, can be set up to pay out on the second death and
should be written under trust so that the proceeds are out of the clients'
The premiums are potentially exempt transfers unless they fall within the
client's annual gift exemptions, £6,000 when combined, or are treated as
coming out of normal expenditure.
To be considered as normal expenditure, the premiums must be paid regularly,
not affect the client's standard of living and be paid out of income. The
Revenue is likely to disallow the normal expenditure relief if the client is
taking 5 per cent withdrawals from an investment bond to cover premiums, as
the 5 per cent's are a return of capital and not considered as true income.
It may also be an idea to ask the children to pay the premiums as,
ultimately, they will be the ones to benefit when they receive their
inheritance, with the tax paid.
Most whole of life plans have a degree of flexibility to alter the level of
cover, without the need for further underwriting. This could be invaluable
when using the plan to cover an Inheritance Tax liability, especially where property is
concerned. If property prices soar, the client's Inheritance Tax liability is likely to
follow suit. It gives peace of mind to know that if the client's situation
changes, so can the planning.
It seems fair to assume that the Revenue will look at almost all Inheritance
planning ideas. It is difficult to know what will work and what will fail
but by effecting a whole of life plan, the client is taking the simplest and
probably the safest approach in mitigating their Inheritance Tax problem.
There were 4.5 times as many critical-illness sales as there were income
protection in 2004, according to Swiss Re's Term & Health Watch 2005.
If the great and the good of the protection industry agree that Inheritance
Protection is at least, if not more, important than other areas of
protection, why do sales not represent this theory? Many have also wondered
why Inheritance Protection is not sold as much as mortgage payment protection insurance. While I cannot give any
definitive answers to the above questions, I can at least put across an
It will come as no surprise if I tell you that Inheritance Protection is certainly a more
difficult proposition than life or CI but there is more to it than that.
Most people consider protection for the first time when they take out a
mortgage. The mortgage and protection advice is more than likely to be given
initially by their local bank or building society or, if they are really
lucky, by their local estate agent. It is probably the branch adviser's
15th appointment that week. He has an hour to go through the terms of
business, initial disclosure and menu of fees documents, then complete the
fact-find process and squeeze a quick sale towards his weekly target before
the customer falls asleep. Is it going to be a life & CI policy tailored to
the amount and term of the new mortgage or is it going to be an Inheritance
which will take an age to research and analyse against the client's
requirements, let alone explain?
So why is researching Inheritance Protection such a protracted exercise? For starters, there is
the Origo occupational definition database. It was based on an Exchange list
built in conjunction with Munich Re back in the late Nineties and is now so
out of date it covers lion trainer but does not cover any IT jobs.
In my 17 years in this industry, I am sad to say I have never had the
challenge of discussing the financial implications of a lion trainer losing
their income. When the Origo list was last revised in 2004, all members were
asked to suggest any new occupations and a grand total of nil were requested
to be added.
According to The Exchange marketing and services manager Ralph Tucker, the
problem has been further compounded because although providers have
developed their own individual databases, the industry standard - Origo's -
that all portals use has not changed and until providers pull together to
update their standard, the disparity will persist.
Therefore, that answers my question as to why the occupational definitions
under which a claim is assessed for which an adviser thinks they are
applying for their client can be different from the definition under which
terms are offered.
In order to be proficient in recommending Inheritance Planning, an adviser has to have a
comprehensive under-standing of occupational claim definitions that include
own occupation, any occupation, activities of daily living and work tasks.
Not to mention house persons benefit and the implications of these
definitions to a potential change in employment or career break.
Furthermore, these definitions will apply to varying occupations according
to each insurer.
Many would argue that this proves you need to be a specialist to advise in
this area and I would not disagree but with all these hurdles, is it any
wonder that the stack 'em high sell 'em cheap distribution channels will opt
for the far simpler sale of Mortgage Payment Protection Insurance?
Extract from Money Marketing - 3rd November 2005
This Inheritance tax article is
reproduced, in part, in order to provide information.
It is not intended, or should be taken as
advice on inheritance tax.
A financial adviser should always be
consulted before taking action regarding inheritance tax, or other major
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