Inheritance Tax Planning For Doctors
Congratulations on getting this far! So many people shun away from Inheritance Tax Planning. Why?
- People don’t like to think about death.
- People are more concerned about the here and now and don’t consider Inheritance Tax Planning until much later in life.
- People don’t realise that they or their estate will be affected by Inheritance Tax.
- People are worried about running out of money in later life.
- People are worried that by doing Inheritance Tax Planning they will give up control of their wealth.
But actually did you know that by starting Inheritance Tax Planning early you can minimise the IHT due, maximise the estate that is passed on to your loved ones, and ensuring you are going to have enough cash at 102!
Inheritance Tax Planning is a bit like a puzzle with several moveable components. I strongly suggest you work with a solicitor and financial adviser whom specialise in this area. They can advise and create a bespoke estate plan for your needs, one that minimises IHT and maximises the wealth that can be passed on your demise.
In the meantime I’m going to give you a flavour of the IHT saving strategies available, it is brief but I’m at the end of an email if you wish to discuss further!
- Spend the money
If the last cheque bounces, result! However, most people want to leave a lasting legacy to their family. In addition as I’m sure you are very aware it is very hard to predict the date of your death. So this isn’t a great strategy for most. I would however say enjoy your retirement! Do a cash flow analysis to see how much you need to live on and how much you can spend on your bucket list.
- Write a will and review your will regularly!
Lawyers, Solicitors, Doctors, you name it, the amount of people that have not written a will is shocking. Speak to a solicitor and get a carefully written up will. There are many IHT strategies that can be done via the will, so don’t skimp on this.
- Make gifts that are not part of your estate for IHT purposes.
You will recall in the previous blog that I mentioned gifts are retrospectively part of your estate if you die within 7 years. Well not all. Some gifts are exempt for IHT purposes. These include;
- Spouse Exemption – No IHT is payable on transfers whatever the value between married couples (assuming you are both UK domiciled in the UK). This is also an efficient way to pass income bearing assets to the spouse on a lower tax bracket!
- Annual exemption – Everyone can give away £3,000, exempt from IHT, in any one tax year. If you did not use the exemption in the last year it can be carried forward, so in the first year of giving you can gift £6000.
- Small gift Exemption – This allows you to give £250 each year to any number of individuals. Very suitable if you have lots of grandchildren, nieces, nephews as you can give each of them £250 for Christmas. However, don’t mix this rule with other exempt rules …..You cannot give someone an exempt gift of £3250.
- Regular Gifts out of Income Exemption – No limit on the amount you can give away but it must be surplus income;
– Paid out of your income (rental, pension, earnings) not capital
-You must be left with enough income after making the gift to maintain your standard of living.
-The gift must be regular
- Wedding gifts exemption – The following people can make free gifts to the happy couple in the following amounts:
–Other ancestors (grandparents) £2500
–Anyone else £1000
–A party to the marriage £2500
- Charitable donations exemption – if you donate at least a tenth of your net wealth (estate after the nil rate band) to good causes, the Government will reduce your Inheritance Tax rate by 10%. This would mean the Inheritance Tax rate applied to your remaining estate would reduce from 40% to 36%.
- Other gifts – All manner of gifts are also exempt, including national institutions such as the British Museum, recognised political parties, universities and other gifts for the national benefit.
Ok so we have started making a dent but obviously a small gift will not create much of a tax saving in your estate. What else can we do?
- Make larger Gifts (And live for 7 years)!
These are known as a potentially exempt transfer. (PET)
It will be part of your estate f you die within 7 years of making the gift but it has the potential to become exempt if you survive 7 years.
Effective but beware;
If you retain a right to the income / enjoyment of the gift it will still be part of your estate for IHT purposes.
If you die within 7 years, the gift will eat away the Nil Rate Band (NRB) first. Once the NRB has been used up the gifts will then be taxed on a sliding scale, known as taper relief as seen below;
+ 3 years 32% (40% x 20%)
+ 4 years 24 % (40% x 40%)
+ 5 years 16% (40% x 60%)
+ 6 years 8% (40% x 80)
+ 7 years 0%
Gifts made after 7 years of death will be outside the estate however if you make a Chargeable Lifetime Transfer (CLT) within 7 years of the PET then it will be added back into the equation. What is a CLT this is a gift into most types of trust in excess of your nil rate band. Bear with me on this point I will come back to it!
Ok so the strategies suggested so far have probably not excited you much, they still don’t satisfy the main objections people have with IHT planning.
- I don’t want my kids to have money too early.
- I would like to keep control of the gift and or how it is invested.
- I would like some flexibility on who benefits from the gift.
- I may I need some of the income / capital later on in life.
- If I pass away and my partner remarries, I’m happy for them, however I would like to ensure my assets go to my children.
- I’m not sure I trust my sons wife.
Yes I have heard them all and they are all valid points.
Listen on, there are solutions!
- Trust planning
By setting up a trust or series of trusts during your lifetime will not only remove the asset from the estate should you survive 7 years, but will enable you to keep control of whom and when the eventual beneficiary will be and in some instances be flexible enough to enable you to have a right to the income and or capital during your lifetime.
In addition trust planning via the will can be an effective way to ensure your estate is passed down through the blood line and enables further IHT planning for your spouse and children.
Trusts are also incredibly useful for pension and life insurance policies. Actually you should make sure your life insurance policy is in a trust (if it isn’t it is part of your estate for IHT purposes).
Now proceed with caution, I have mentioned some of the great features of trusts. However they do need to be set up and managed correctly. Different types of trusts have different features from a flexibility, tax and income perspective. I’m not going to go into the nitty gritty of different types of trusts but if you wish to know more jump to the end of the article where I have given further detail on a taxing issue!!
- Make use of reliefs to decrease the estate subject to Inheritance tax
Inheritance tax reliefs allow some assets to be passed on free of inheritance tax or with a reduced bill. The executor of a will or administrator of an estate should claim the reliefs when they’re working out how much the estate is worth. Three common types of reliefs are;
Woodland, agriculture and Business property relief.
Now many of us don’t own a farm / woodland / winery (although the latter could be a nice option) and it is relatively hard to invest in these types of assets for capital growth and liquidity. However business property relief provides a very good option for a whole host of clients.
- Business property relief
One of the key advantages of investing in an asset that qualifies for business property relief is that the asset will be outside your estate for inheritance tax purposes after 2 years assuming you still own the asset and do so at time of death.
So how can you access this market; The relief can be claimed on a business, interest in a business, unlisted shares, or many of those quoted on the Alternative Investment Market (AIM).
Business I hear you say, I have a business does that meant it won’t be part of my estate?? Well maybe yes, but come on its HMRC they are cleverer then that; if you have a large hoard of cash in the business that is surplus to requirements it won’t qualify.
So how can we access this; Well you can invest in an AIM IHT portfolio. As a whole these are characterised as very volatile although they have done fabulously well over the last 5 years.
There are also more ‘capital preservation’ IHT investments offered by a number of investment houses. These invest in to assets / companies that tend to have reliable income stream for example solar and renewable energy, business lending, property finance, care home.
Investing in business property relief is a simple way to mitigate the tax bill whilst keeping full control of your assets and wait for it, you can even set up a corporate IHT structure….. So Doctors and surgeons if you have a private practice with too much cash in it, then yes you may be able to get the cash working harder for you and move it outside your estate for IHT purposes!!! This is why I love my job! This is sexy planning, but there are a lots of providers, fees can be high, take advice from an IFA and accountant to ensure it works for you now and on sale of the business. I will talk further about this point in the article planning with your business.
Back to one of my favorite wrappers! Most types of pension do not form part of your estate for inheritance tax purposes and grow in a tax efficient manner. So much so that clients get quite shocked at me when I tell them to pile into their pension (up to the tax efficient threshold obviously) and yet when they reach retirement I say oh gosh no don’t touch your private pension! Or at least don’t use up too much of your private pension, utilize other investments first!
I say most types of pensions…. Very old type of contracts may be part of your estate for IHT purposes (check with an advisor) and for pensions to not be part of the estate you do need to ensure that on the death benefit form you have said you would like the trustees to tak into account my wishes on where the death benefits go. If you have requested that death benefits go at your direction they will be part of your estate. This is quite important and I suggest
- Insure the tax bill
A simple option is to insure the inheritance tax bill through a whole of life policy. Whole of life policies will pay the sum assured on death. The policy will be written into trust and the premiums should be eligible to be claimed under the habitual gifts from normal expenditure. Therefore the policy will not form part of your estate for IHT purposes. The sum assured can then be used to pay the IHT bill quickly and efficiently.
Policies can have a guaranteed or reviewable premium. As a rule of thumb guaranteed premiums are preferable as we can budget this into your income requirement. However they can be expensive, as such reviewable premiums can be a good option particularly if we are covering a larger bill / gifts in the early years with the view that in the later years the IHT bill would have decreased.
It is important to stress if you chose a guaranteed premium you must ensure that it will still be affordable in the later years. If the policy were to lapse you would receive no pay-out.
So there are the basic tools for minimising Inheritance Tax.
There’s no silver bullet! Estate planning is a ‘chipping away’ exercise – the earlier you start, the more effective your planning will be and the fewer risks you’ll have to take. In addition by careful planning utilising the right wrappers and investment vehicles at the right time you can minimise taxes in your lifetime and death and in doing so maximise your estate that goes to your loved ones.
It is not rocket science, yet it is taxing! If you want to speak to me further feel free to get in touch at firstname.lastname@example.org
For those that want to read on, please find below further info on trusts…😊
Trust planning continued
As a rule of thumb there are two types of lifetime trusts for tax purposes and flexibility of beneficiaries. These are known as Bare and Discretionary.
A bare trust is an absolute trust, it is absolutely 100% for one beneficiary. The beneficiary cannot be varied. Gifts into in to a bare trust will be known as a potentially exempt transfer and tax in the trust will be at the beneficiary’s rate. (Please note this assumes the trust was not set up by the parents during the lifetime and the trust income does not exceed £100 per year, if that is the case then the trust will be taxed at the parents rate). So a bare trust is ideal for a grandparent gifting money to a grandchild, the only snag is that it is the child’s money and at 18 they can do what they like with it, whether that be buy university books or a motor bike.
A discretionary trust is far more flexible in terms of whom the beneficiaries are, and these can be changed as the trustees (the owners of the trust) discretion. A discretionary trust however is subject to relevant property regime tax rules. This means that money going into the trust will be classed as a CLT, tax of 20% will be due on gifts in excess of your nil rate band that go into the trust. If you don’t survive 7 years then further IHT will be due on the gift. The money in the trust will be taxed at the additional rate, and there are potentially exit charges on money distributed from the trust and periodic charges every 10 years.
Don’t get scared it doesn’t mean these are very tax inefficient. It just means we have to be slightly more intelligent on the amount of money we put into this type of trust, the timing of the gift and the underlying investment vehicle. For example, gifting up to your nil rate into a trust every 7 years will prevent any immediate chargeable lifetime transfer, investing the money in a tax efficient wrapper will minimise and in many cases prevent income and capital gains tax, and the timing of distributions can minimise the exit /periodic charges.
The key with trust planning is doing little and often, chipping away at the IHT bill rather than trying to do the planning in one fowl swoop. I would also suggest you work with an IFA and solicitor that specialise in this area. It is not one to make mistakes on.
There are a variety of investments trusts that IFA’s recommend for clients (this is not advice) more to give you a flavour of some of the solutions:
- Loan Trust
This is where you effectively loan money into a trust and all growth is outside the estate from day 1. You can still access the money loaned into the trust. Great if for example you have £400,000 which you know you will need in the future but you know you will not need any growth on this capital.
- Discounted gift trust (DGT)
This is where you make a gift into a trust but retain a right to an income. An initial discount on the gift will be applied; the discount is calculated by the actuaries and will be dependent on your age, health and income requirement.
Say for example you are 60 years of age and gift £200,000 into a DGT, yet require an income of £5,000 per year. The actuaries calculate that the actual gift going into the trust is £110,000. i.e. an initial discount for IHT purposes of £90,000. So by setting up a DGT you would have reduced the estate subject to IHT by £90,000 and will remove a further £110,000 in 7 years.
The income you receive from the DGT will be tax deferred, so a great way to maximise ones estate in retirement as it means you can take this and less from your pension which will be taxable.
- Flexible reversionary trust
This will allow you to still have access to the money and after 7 years will be outside your estate for inheritance tax purposes. This is a flexible strategy for income purposes, however is only effective for inheritance tax mitigation after 7 years.
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