Intergenerational Tax Planning Matters

Clients no longer have to be super wealthy to find themselves with an IHT problem, but there are a number of solutions, says Downing

There’s nothing surer than death and taxes – and dying isn’t cheap. This fact was pulled into sharp focus at the beginning of August when officially released figures showed inheritance tax (IHT) receipts hit a total of £5.2 billion in 2017/18 – their highest ever level. The total is almost a £400 million increase on the previous year and could be predominantly due to booming stock markets and soaring property values in the year to 5 April 2018.

People are living longer, and it is not unusual for four generations of the same family to be alive at the same time. The growth in the amount paid to the taxman on death underlines the importance of financial planning, not just as an individual, but on an intergenerational basis. With house prices increasing, more people could be affected by a hefty IHT charge. Not making considered decisions around IHT planning could prove a costly mistake for beneficiaries and many people could unwittingly contribute more to HM Revenue & Customs (HMRC) than they need to.

Rising property prices equals rising IHT

It is important to note that you don’t have to be particularly wealthy to leave behind a large IHT bill when you die. Currently, taxable estates worth more than £325,000 (over the ‘nil rate band’) are subject to 40% IHT. The government has introduced an additional allowance when a residential property is passed on to a direct descendant, called the ‘residence nil rate band’, which will increase annually over the next four years to £175,000 per person. Effectively, by 2020/21 the total value of an estate that may be left to direct descendants free of IHT will be £500,000 per person (or £1,000,000 for a married couple/civil partnership) subject to conditions. However, house prices have risen by more than 30% since 2009/10 according to the Office for Budget Responsibility (OBR), so more and more estates will be liable to pay IHT.

Planning across generations

Today’s older generation might well be considered the ‘lucky ones’, with many owning their own homes and benefiting from generous final salary pensions. At the other end of the family spectrum, there can be young relatives saddled with student debt, who have far less opportunity to get on the housing ladder, and who face an uncertain economic future. People are also living longer so they may have to plan for longer periods of retirement and the possibility of living their final years in a care facility.

Inheritance planning should ideally take place after careful consideration of individual requirements during retirement. There are various tax efficient ways of passing assets to descendants, but these come with a myriad of constraints and obligations. Traditional estate planning solutions can be inflexible. For example, if you give away your assets to family and friends during your lifetime, these gifts take seven years before they become exempt from IHT.

Similarly, putting assets into a trust also takes seven years before the value of the assets falls outside of the taxable estate. Both of these options result in you no longer being able to access your wealth if you need to. Also, for many people, gifting their hard-earned money when they are alive can be very unappealing – trusts are complex, and the individual may feel they have lost control of where there money has gone.

Gifting assets is an alternative, but this also has restrictions as it has a maximum of £3,000 a year, so it’s not the most flexible option, and unused gift annual exemption can only be carried forward by one tax year.

Advisers predict growing demand for IHT advice

Unsurprisingly, recent research shows that more than threequarters of advisers expect the number of retail investors requiring help with IHT planning to increase over the next three years. And two thirds of advisers expect to see the use of business relief (BR) rise over the coming three years as people look to reduce their IHT liabilities.

BR was introduced by the government to allow smaller businesses to be passed down either IHT-free or at a reduced rate. It is available on smaller UK unlisted companies (and those listed on AIM or the NEX Exchange Growth Market) which carry out a qualifying trade. The benefits to the investor are that after two years of ownership the shares no longer count towards the individual’s taxable estate and are therefore free from IHT provided they are held at death. The shares can be held directly, within an ISA, or within a specialist IHT portfolio.

For investors managing their own portfolios, trying to identify which stocks qualify for BR can be confusing. There is no definitive list because the qualification status of a company can change over time, and there is no guarantee that companies currently qualifying for BR will do so in the future. Additionally, it should be borne in mind that investing in unlisted companies and AIM stocks can be risky. Most of the businesses are young and smaller than those listed on the main market and share price volatility is not uncommon.

The risks associated with investing in AIM, and the complexities of the tax exemption rules can form a barrier to investors selecting their own qualifying shares. Instead many prefer to appoint specialist managers to build discretionary AIM portfolios designed to minimise IHT bills.

ISAs are not exempt from the ‘death tax’

ISAs have proven very popular since their introduction back in 1999, and today more than six million of the UK’s 23 million ISA investors are over 65 years old. Many will be starting to think about how they can pass on their wealth as effectively as possible, but many may not have considered that the value of the investments and cash held in ISAs are usually counted as part of the taxable estate.

Those who have used the wrapper and built up a substantial sum to pass on to their heirs may be oblivious that it could be subject to 40% IHT. However, a rule change was introduced five years ago that allowed AIM-listed shares to be held within a stocks and shares ISA. By buying the right type of BR-qualifying AIM shares, investors can enjoy the potential for tax-free growth and dividends within an ISA wrapper while they are alive and pass them on free of IHT, as long as they have been held for more than two years and at death.

ISAs have proven very popular since their introduction back in 1999, and today more than six million of the UK’s 23 million ISA investors are over 65 years old

Will the rules be tightened?

The growing popularity of the BR tax break has caused some to question whether it will become a future Budget target for the exchequer. We think it will stay on the radar of the Chancellor, but the government has stated that it remains committed to protecting the important role that this tax relief plays in supporting family-owned businesses, and in encouraging investment in the AIM and other growth markets.

The fact that one day you will die is an uncomfortable truth – as is the fact that ‘you can’t take it with you’. The number of families caught in the IHT net is increasing, which represents a significant opportunity for advisers specialising in IHT and intergenerational planning. A forward-looking approach is vital when it comes to protecting and planning your family’s wealth for future generations and individuals should look for advice on which IHT services offer a straightforward, effective and flexible way to accrue and pass on their wealth.

Important notice

This is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. An investment should only be made based on the relevant product literature. Downing does not offer investment or tax advice or make recommendations regarding investments and we recommend investors seek professional advice before deciding to invest. Capital is at risk, you may not get back the full amount invested, and tax treatment depends on the individual circumstances of each investor and may be subject to change. The availability of tax reliefs depends on investee companies maintaining their qualifying status. Investments in smaller companies will normally involve greater risk or volatility than investments in larger, more established companies.

Any personal opinions expressed are subject to change and should not be interpreted as advice or a recommendation.

Downing is authorised and regulated by the Financial Conduct Authority (Firm Registration No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House,3 Lower Thames Street, London, EC3R 6HD.

Laurence Callcut

Partner & Head of Sales Downing LLP

Contact us

Downing LLP is a London-based investment management firm formed in 1986. So far, over 35,000 investors have been a part of what we do, and we are proud to have raised over £1.7 billion into businesses across a range of sectors.

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