The WAY Group Newsletter for Financial Advisers | July 2009
IHT simply won't go away!
Inheritance tax planning has fallen down the agenda for many IFAs in recent times. The introduction of the transferable nil rate band and the premise that the Conservative Party will stroll into power and implement a £1million pound nil rate threshold has altered the sense of urgent need that once accompanied the identification of a prospective IHT estate bill.
For clients of a certain age and with attendant pension concerns delay could be a dangerous option, we look this month at a not uncommon personal dilemma ...
Jack Frost is a reasonably fit and healthy 74 year old entrepreneur. He has a wife, children and grandchildren and soon a first great grandchild. His mind is currently fairly focussed on the fact that he is fast approaching 75 when he will have to convert his pension pot into an annuity, whilst a recent attempt to acquire a whole life policy to mitigate Inheritance Tax (IHT) has told him that he has a couple of health issues which rate him as an 80 year old rather than his real age of 74. He has heard that the Tories are talking about increasing the Nil Rate Band from the current £325,000 to £1 million as well as scrapping compulsory annuitisation at age 75 and reducing the penal levels of IHT on Alternatively Secured Pensions (ASPs). He is looking for some guidance from his financial adviser as to whether he should take any action ahead of both the General Election and his 75th birthday.
In some ways Jack is being forced into making decisions now because of his age and state of health. Someone slightly younger may be able to sit on the fence a little longer to see whether the Tories do manage to win the election and they then make the changes they have recently announced. What are these changes? At the recent ABI conference on saving, Shadow Chancellor George Osborne confirmed his intention of increasing the IHT threshold to £1 million as part of the Tories tax simplification programme. Of course there is no definitive timetable for this exercise! Meanwhile, Shadow Pensions Minister Nigel Waterson has recently said that the 82% tax charge on ASPs is punitive. Quite separately the Tories have committed to scrap compulsory annuity purchase at the age of 75.
This raises several questions in general and one or two which particularly affect Jack and his family. The first question is whether the Tories will win the next general election. This may seem a frivolous question after the tumultuous events of the last few weeks in parliament. But the polls, whilst putting Cameron well ahead of Brown and the Tories well ahead of Labour, still show that the only person really trusted with the UK economy right now is - Gordon Brown. Now, imagine the recovery really taking hold ahead of the next election, against a backdrop of other economies still struggling, and all the electioneering from the Brown camp benefitting from all the filmed accolades from world leaders around the G20 conference. Imagine the Tories and Liberal Democrats still suffering from their policy vacuums. It is quite possible to envisage Gordon Brown slipping back in with a much-reduced Labour majority. Then all these Tory promises will mean nothing because they will remain in the wilderness.
On the other hand we could instead rely on conventional wisdom and assume that the Tories win the election. The second question focuses on whether, when they see the books for the first time, when they see the full extent of the deficits and the challenges involved in turning that position around, they will urgently reduce taxes and clean up these anomalies? It would be nice to think so but it rather beggars belief. I think Ken Clarke got it right when he said that it was a noble objective which would be achieved during the next parliament - but over what period of time? Will they remove transferability of the Nil Rate Band perhaps, or introduce the higher threshold over a five or ten year period? Nobody knows.
Jack has other pressures quite apart from the uncertainty over the election. He has been rated to age 80 which means that he has about 7 years of life expectancy left. That happens to coincide with the inter vivos period when gifts fall out of account for IHT. If he defers making gifts they may be caught within the IHT net if he dies within 7 years. Can he afford to gamble that he will live long enough to see a £1 million threshold and that his prospective ASP pension pot will avoid the 82% tax? Probably not really, because birds in the hand are pretty much always worth more than those in the bush.
If Jack decides to wait out the next year to see what happens, or possibly he will just feel unable to make a decision because of all of the uncertainty, he then enters a whole new scenario because of his age. If he does nothing and is then forced into taking an ASP when he is 75 his options will become extremely limited. He will then be committed to that route and even if the tax regime changes he is unlikely to escape 40% IHT (and probably more or even up to 82%) on any residual value within the ASP. Obviously the Tories may make the rule changes retrospective for all those previously forced into ASPs but this is not likely because of the work and complexity of unwinding everything. In any case their kudos will be in making changes for the future and not in rescuing recently disadvantaged individuals. Jack would also be reducing the likelihood that he could make any capital gifts and survive the necessary 7 year period to achieve IHT exemption and the return of his Nil Rate Band.
In reality Jack needs to get as much of his pension pot out of the reach of HMRC straight away, by taking maximum tax free cash and gifting it away via a flexible trust, particularly if he can take advantage of using his current exemption to completely remove potential IHT liability over the next 7 years. By the same token he also needs to establish an annuity at the highest rate possible to strip as much further value from his pension pot. If this is being removed via a specialist annuity with high levels of 'drawdown' then the after tax income can be gifted using the 'normal expenditure' exemptions, straight into another flexible IHT trust. If the income suffers a full 40% tax that is no more than the rate of IHT it might otherwise suffer and a great deal less than the 82% suffered by any residual value passed via an ASP.
If Jack were to take his tax free cash and a maximum annuity to take advantage of all the tax breaks currently available, only to find the Tories do enter government and take him out of the tax net, then it is important that he has used the most flexible and tax efficient trust arrangements currently available. Such trusts incorporate sufficient flexibility to adapt to Jack's new low IHT environment.
Paul Wilcox
Chairman & Technical Director, WAY Group
Ends-
Contact WAY for details of the WAY "Gifts From Income" Plan and WAY Flexible Inheritor Plan both of which could assist Mr. Frost's dilemma.
How to contact us
If you wish to discuss the contents of this e-newsletter or 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.
Note: This article first appeared in the New Model Adviser magazine. Reproduced with kind permission.
Newsletter: July 2009.
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.