Crystallise losses for the taxman now. Mark Benson demonstrates how IFAs can capitalise on the current market conditions to help investors downsize their tax exposure.  Photo left: Mark Benson, WAY Technical Manager.
It's doom and gloom wherever you look right now. The Great British Summer of 2008 will go down in the record books ...as well as down the drain. Mortgages are a figment of an American banker's imagination ...or "insecuritisation". And many investors' portfolios appear to have successfully participated in a weight-watchers slimming plan - unlike some of their owners! Opportunity knocks
But in every situation, there are opportunities. While it is sensible for equity investors not to panic and abandon their portfolio strategy, they should not sit on their hands and do nothing. Indeed, depressed valuations offer an excellent opportunity for the creative adviser to undertake some highly profitable tax planning for their clients, whilst maintaining the portfolio risk profiles. This will prepare them for the sunnier days that we know are ahead. For example, now is an extremely good time to suggest moving investments to significantly reduce an investor's Inheritance Tax (IHT) liability. Think about it – you may be happy with fund growth of say 10%, yet if appropriate IHT structures are not in place, some or all of that investment could go down the 40% drain. As we discuss elsewhere in this e-newsletter, the threat of IHT to family wealth is unlikely to recede any time soon and it is therefore as important as ever to reduce your clients' IHT liability. Also, it is an unavoidable fact that we are all getting older and since the key to reducing IHT is to gift assets into trust and then survive for the seven year inter-vivos period, the sooner the gift is made the sooner and more certain it is that the seven years is survived. Technical talk
Here's the technical bit. Passing assets into the hands of trustees, and out of the estate of the investor, will create a number of "chargeable events" (or potentially chargeable events) for IHT and one of the lifetime taxes. For example, the encashment of an existing investment to provide funds for the transfer may result in an assessment for Income Tax on a bond or CGT on a unit trust. The transfer of the lump-sum funds into trust will either be a Chargeable Lifetime Transfer (CLT) or Potentially Exempt Transfer (PET) for IHT purposes depending on the type of trust used. However – and this is key – in all cases, and for all taxes, the potential or actual tax bill will be lower if the amount of money gifted is lower. In the current market, the investment portfolios are lower so now is the perfect time to do this. Delaying could make it worse, not better. Clients on cloud nine
So while everyone else is gloomy, those clients who can conduct IHT planning now in the current market climate should be on cloud nine. The losses are crystallised for the tax man, but not for your clients who can continue their investment strategy within the shelter of the trust. This example shows how much tax can be saved by exploiting the current low market prices: - You advised your client to invest £100,000 into the WAY Red Portfolio Fund on 29th January 2004 at a price of 83.7 pence.
- As at 8th August 2008 his investment had grown to a value of £127,822 (bid price 107 pence).
- In the intervening years as well as enjoying the growth in the WAY fund your client has seen the value of his home increase significantly and has further built his wealth through his business activities.
- Whilst your client is very happy to be a prosperous individual, you have realised that a significant potential IHT liability has developed. You therefore recommend that he gift his units into a WAY Flexible Inheritor Plan as part of an IHT planning strategy.
As at 8th August 2008 therefore, the following tax chargeable events occur: - A deemed disposal for CGT realising a gross gain of £27,822 and a gain net of your client’s CGT annual exemption (£9,600) of £18,222. Your client must therefore pay 18% CGT, or £3,280 on the deemed disposal.
- A Chargeable Lifetime Transfer for IHT of £127,822. Your client has not made any previous CLTs in the last 7 years and so there is no IHT to pay as the transfer is well within the Nil Rate Band.
This works for unit trusts. Not for bonds.
It is worth noting that many investors may actually be sitting on unrealised losses in the current environment rather than reduced gains. This seeming disadvantage can be turned to the client's advantage when undertaking a switch from assets liable to CGT into an IHT mitigation trust since net capital losses in one tax year can be carried forward indefinitely and used to reduce taxable gains in future tax years. This benefit is available under the CGT regime (so it applies to unit trusts) but it is not available under the Income Tax regime (so will not benefit bond investors). Returning to our story ... Taking this action now brings the following benefits: - All growth is immediately outside of your client's estate and does therefore not increase the potential IHT liability.
- Your client has access to the capital plus the growth via the bespoke reversion schedule.
- After seven years the whole of the trust fund (capital plus growth) will be outside of the estate thus saving 40% of that value in IHT.
What happens if you "wait and see"?
So what would happen if your client waited until November 2010 to undertake the IHT planning? Suppose that in the interim period there has been a significant recovery in world markets (if only we could tell you when!). The units in the WAY Global Red Portfolio are now worth £162,269. The tax chargeable events (assuming no changes to the tax rules in the interim) are: - A deemed disposal for CGT realising a gross gain of £62,269 and a gain net of your client’s CGT annual exemption (let’s say £10,400) of £51,869. Your client must therefore pay 18% CGT, or £9,336 on the deemed disposal.
- A Chargeable Lifetime Transfer for IHT of £169,269. Again, assuming that your client has not made any CLTs in the previous seven years there is no IHT to pay as the transfer is well within the Nil Rate Band.
The disadvantages of delay
So delaying brings with it these disadvantages: - The initial CGT charge has almost trebled, from £3,280 to £9,336, an extra £6,056.
- The CLT has increased from £127,822 to £169,269 which would result in an extra £16,579 (£169,269 - £127,822 = £41,447 x 40%) being paid in IHT should the client not survive the seven year inter-vivos period.
- The client must survive until November 2017 for the initial transfer to fall out of estate, rather than August 2015 under the first scenario.
- The significant growth enjoyed during the markets' recovery is in the client's estate (not within the trust) and is therefore adding to their IHT problem.
While the larger gains captured in the trust would increase the potential CGT liabilities of the trust when the assets are eventually appointed out to beneficiaries, the trustees have a great deal of control over the appointment of assets and by prudent management of the distributions will be able to significantly reduce or even eliminate this CGT liability. Why you should act now
Now is an excellent time to undertake IHT planning because: - The lifetime tax charges incurred on disposal or deemed disposal of existing investments is reduced or eliminated when compared to disposals when markets are high.
- Losses on shares, unit trusts and other collectives can be carried forward and used to reduce CGT in future years.
- The size of the transfer for IHT purposes is lower which reduces the potential IHT charge on a death within seven years and allows a greater proportion of a client's investment portfolio to be switched into a flexible trust within the Nil Rate Band.
- Where WAY’s suite of IHT products are used the client can still benefit from the eventual recovery in asset values, since all of our products offer capital plus growth in the interest carved out for the client, whereas traditional DGT schemes irrevocably gift the growth to the beneficiaries.
"Bet on the Tory’s £1m IHT limit at your peril." Stuart Howard, Managing Director of Fareham-based IFA Cassidy Coutts Donald, looks for an all-weather IHT solution.  Photo left: Stuart Howard, Managing Director of Fareham-based IFA, Cassidy Coutts Donald.
The Conservative party are in clover. With GB looking sadder day by day (that's both Gordon Brown and Great Britain) the Tories are a good bet, at the moment, to win the next election. But that's likely to be 2010 - a dangerously long time to hold a 'polling majority'. One area that the Tories have indicated they plan to change is Inheritance Tax (IHT). The main area of change is the idea of increasing the Nil Rate Band (NRB) from £312,000 to £1million per person. In itself this would be an incredible development. Such a change in, say, income tax would be like increasing the personal allowance from £6,035 to £19,342. So what chance they would make this amazing IHT change, assuming they get in? Here’s what’s happened so far: - Last October, the Tories pledged to raise the NRB to £1million per person.
- They have recently been compromised into confirming that their announced £1m NRB will be transferable. It has been "confirmed" by Theresa May, shadow leader, that because the NRB limit can be transferred, in effect the NRB per couple would be £2 million.
- But in the last couple of weeks George Osborne, shadow chancellor, has been complaining that Labour will leave the economy and government finances in such a mess they are not sure they can quickly deliver any tax reforms which reduce the tax take.
- The cost is estimated at £2bn per annum. This would be a big hole in government finances which would be extremely difficult to fill.
- They have announced that they will raise extra revenue by taxing non-doms £25,000 per annum. But when Labour introduced a £30,000 tax for non-doms who have been here for more than seven years, it created an ongoing furore. So any further moves are going to be very difficult and counter-productive in selling London as the financial and business capital of the world.
- There is a significant groundswell of feeling, demonstrated in regular debates in the House of Lords and elsewhere, that IHT at a reasonable level is a good thing in addressing major inequalities within society. The fact that 19 members of the shadow cabinet are (allegedly) millionaires implies a great deal of self interest.
In any case let's not forget that the Tories are in opposition and we all know that frequently new governments fail to deliver on manifesto promises just because they realise they cannot practically do so. It is interesting that Osborne has not been drawn on the timing of such a move. Bearing in mind that he has been compromised into agreeing to retain transferability it is probable that the Tories will initially increase the individual NRB to £0.5m so that there is a joint allowance of £1m. What should taxpayers do now?
It is far too risky for people to just assume that IHT will go away. It and its predecessors have been with us for 100 years. Investors need to know that, whatever happens, their estate, including their investments, is protected. What's required isn't a heads or tails choice but a heads and tails opportunity so that the investor is protected whether the NRB goes to £1million or broadly stays where it is. There aren't many ways of achieving this but it can be achieved by utilising WAY's market leading fund and trust structures. "WAY has always been at the forefront of IHT mitigation and their trust structures are both extremely robust and very flexible", said Stuart Howard of Fareham-based IFA Cassidy Coutts Donald. "The ideal is to have a trust structure that both shields the investor from IHT but still gives the settlor the control to deal with life's twists and turns. Only WAY's structures provide these very important elements for both capital and income surplus." "And so, in this uncertain situation when we don’t know if the NRB is moving to £500,000, £1million or £2million, investors need to be certain that whatever happens, they are in control. WAY delivers that certainty", Howard said. How to contact us
If you wish to talk to someone about the issues raised in this e-newsletter or about any of WAY's products, please feel free to call either your local Regional Sales Manager or Tony Lyons, IFA Support Manager, head office telephone number: 01202 890895. Or you can use the website: Contact Form to get in touch. We look forward to hearing from you. - Ends - Link - the: WAY suite of trust structures Newsletter: September 2008. Please Note: This newsletter commentary has been prepared for Financial Intermediary Clients and Professional Associates of WAY Investment Services Ltd and is not intended for and must not be distributed to Private Investors. This information is supplied to you in confidence and you may not pass it on to any other party without prior written consent. Past performance is not necessarily a guide to future returns and changes in rates of exchange between currencies may cause the value of investments to rise or fall. No representation or warranty is given (express or implied) as to the accuracy, completeness or correctness of the information nor the opinions, interpretations and conclusions contained in this commentary. The commentary does not constitute investment advice or a recommendation to purchase or sell any security. Neither the author nor WAY Investment Services Ltd accept any liability whatsoever for any loss or damage arising in any way from any use of or reliance placed on the commentary. WAY Investment Services Ltd is an Appointed Representative of WAY Fund Managers Ltd which is authorised and regulated by the Financial Services Authority. |