It’s a full-time job keeping up with the changes and developments in any one area of financial planning, let alone all the major areas. We tend to find that people focusing on one particular type of planning can mean forgetting about more niche aspects that can have quite an impact in other areas.
We’ve considered what might be some of the ‘forgotten’ areas in planning and created a small list. This first one will focus on estate planning. People are by now familiar with the complexities of the Nil Rate Band (and especially the RNRB) and the use of trusts/insurance/gifts and business relief (BR) to mitigate tax. There are three things, however, that we have identified as either causing an unintended problem for clients, or being aspects not always accounted for in inheritance tax planning.
Annuity guarantee periods and value protected lump sums can form part of the estate for inheritance tax purposes
Unless the beneficiary of a guaranteed period under an annuity is the legal spouse, a value needs to be attributed to the estate for inheritance tax purposes. HMRC provide a calculator for calculating the ‘open market value’ of the outstanding income. This figure would be included in the individual’s estate for inheritance tax purposes.
For those aiming to minimise Inheritance Tax and with Defined Benefit/Annuity pensions and no spouse, this is something to consider. For example, if an individual died 5 years into the guarantee period, and the annual income was £25,000 per annum (increasing at 2.50% per annum), the HMRC calculator yields a figure to be included in their estate of £83,738.
What this means is that it is not simply a case of the assets in the estate that need considering for inheritance tax planning, but also the ‘notional value’ of a guaranteed income.
Value protection is another popular form of annuity protection available. This is more straightforward and represents the net payment to the estate. The ‘net’ aspect is due to whether the benefit is taxed or not (death before or after 75). As much as value protection aids in annuity purchase planning, potentially 40% of the ‘tax-free’ benefit paid back can be lost to IHT which would otherwise have not been the case within a pension! Again, this supposes there is no spouse to receive the value protection lump sum.
The two-year IHT rule on pension switches does not benefit from the spousal exemption
Pension death benefits and IHT again. The calculation of the ‘transfer of value’ has been somewhat simplified by the ability to use UFPLS in place of a 10-year guarantee period, but it’s worth noting that even if the spouse receives the value of the pension death benefits from the new scheme, the ‘transfer of value’ is not exempt.
This is because the transfer of value is between two trust (pension) schemes.
Some good news to counteract this though, the calculation of the ‘transfer of value’ is usually a LOT lower than the fund value or CETV.
Essentially, you are working out the net UFPLS value (based on the individual’s actual tax rate) and subtracting this from the Fund Value/CETV to find the ‘transfer of value’
You can also discount the original value to reflect the time of life expectancy – though this is unlikely to be by more than 5% / 10% based on the 2-year aspect.
A very simple example of this is if an individual had no taxable income and accepted a CETV of £170,000, the net UFPLS could be:
£42,500 is tax-free as 25% of the fund
£127,500 is taxed as:
- £37,500 at basic rate = £7,500
- £90,000 at higher rate (no Personal Allowance) = £36,000
Net value = £170,000 minus £43,500 tax = £126,500
The transfer of value, before considering any ‘discount’ factor, is £43,500 as this is the ‘loss to the estate’ in this calculation. This is despite that in reality, this isn’t a loss to the estate as the calculation uses the CETV in both instances, instead of the actual Defined Benefit death benefit structure!
The two-year rule, and the calculation to check the value is ultimately something to be aware though, in reality, it is unlikely to be a significant figure relative to the CETV that a client is securing for their estate by transferring.
Too much cash (or investments) within a business can impact eligibility for Business Relief
Successful companies can end up with quite large retained profits on deposit, particularly if the proprietor is not drawing much of the profit as remuneration or reinvesting into the company. Whether this cash is invested on the company’s behalf or retained on deposit, there can be tax issues down the line for the owner(s).
In terms of Business Relief, and hence efficiency for inheritance tax planning, excess cash in the company can all foul of ‘excepted assets’ rules. This seeks to prevent personal assets held within a company to provide shelter from inheritance tax.
While many businesses’ legitimately keep reserves in place for a variety of reasons, including not least as a buffer against a future economic downturn, HMRC takes the view that this is not sufficient reason for cash to be retained with the company.
What HMRC appear to look for is evidence of business planning for the funds and this could take the form of written plans for future cash use.
The ultimate implication is that the value of the business assets made up by this proportion may not qualify for Business Relief. This could introduce a potentially large amount of assets in the estate value and derail some of the planning otherwise made!
The same is potentially true of general corporate investments. There is no general distinction between cash or investments in this manner so if cash held by a business is deemed not to be for legitimate business use, investments will likely be so too (it would probably be harder to prove legitimate business use for an investment).
This obviously doesn’t mean a business should not hold surplus cash or invest, but it does mean business owners cannot necessarily be assumed as having 100% exception to IHT.
Grant Callaghan – Head of Paraplanning
Next up: Forgotten planning points around pensions (unrelated to Inheritance tax this time).