Wheezes for Lifetime Tax Planning

Firstly, a note of clarification, just as the Speaker of the House of Commons may require for Hansard. “Wheezes” is used in its broadest and most proper sense and implies nothing of the sort “dodgy”. Indeed, a Member has been ejected from the House for refusing to retract his use of the word “dodgy”, and I certainly wouldn’t want to suffer the same ignominy.

Secondly, a word of warning. The following does not constitute legal advice or reliable tax advice. As we all know, the tax landscape changes frequently, and in the present circumstances the country has placed itself into such a state of indebtedness to cope with the Government’s policy response to the coronavirus that taxation changes may very well be just around the corner. All that is intended from the below is that you have a starting point for your thought process – but take advice!!! (!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!)

This article deals predominantly with examples of how you may be able to plan to minimise the taxes due on your wealth when you shuffle off this mortal coil. Some of this will involve steps you can take during your lifetime and some of it steps you can plot and plan in your Will. On the lifetime side of things, it will largely involve giving assets away – needless to say, do not give away so much that you cannot support yourself. It has unfortunately been known that people give away their assets, thinking that the trusted recipient will “look after” them and that they are making a sensible tax saving, only to find that their trust has been misplaced. You can of course set up an actual trust, but that itself will have tax consequences. You being able to afford to live your life is immeasurably more important than a tax saving.

Actions (that may) be taken during Life

  • If you think you might die in the next 7 years, give away £3,000 every year to family or friends

This is your annual exemption from Inheritance Tax – if you die within 7 years then these gifts will not affect your liability to Inheritance Tax. If you didn’t use last year’s £3,000 allowance, you can use it this year as well.

  • If you really think you’re going to die in the next 7 years, make sure you give your children £5,000 as a wedding gift

Only if they’re getting married of course. The payment will be exempt from Inheritance Tax. You should also give £2,500 as a wedding gift to anyone else in your family. And if you’re feeling really generous, £1,000 to your friends when they get married. But don’t forget to die within 7 years otherwise it’s pointless from a tax saving perspective.

The gift will also be exempt from Capital Gains Tax – not because it’s a gift in consideration of marriage, but because if it’s cash then cash is not a chargeable asset for CGT, and if it’s some tangible moveable property then it will be exempt if its value on disposal is £6,000 or less, and of course £5,000 is less than £6,000.

  • You can also give gifts to charity or to your husband or wife

These can be of any size and are totally exempt from Inheritance Tax. Again, it’s only really useful for tax saving if you die within 7 years, unless the gift to your spouse is actually for one of the other reasons explored below.

  • If you are a higher or additional rate tax payer and your wife or husband is a lower rate tax payer, give them some of your income-producing assets

Of course, you have to trust them. But if you do then this will allow the income produced from those assets to be taxed at a lower rate than it would if you kept hold of them. For example, the additional income tax rate on savings income is 45%, whereas the basic rate is 0% for the first £1,000 and 20% for the rest. Your spouse will be a basic rate taxpayer if her annual income is between £12,501 and £50,000 (the income from the asset in question will have to be taken into account within this). Of course, if she doesn’t earn anything at all then the first £12,500 of the income from whatever asset you transfer to her will fall within her annual Personal Allowance, with no charge to income tax. No charge is better than 45%.

  • If you are a basic rate taxpayer and your wife earns less than £12,500 per year, transfer up to £1,250 of her unused annual exemption to yourself

Broadly speaking, you will be a basic rate taxpayer if you earn between £12,501 and £50,000 per year, which is taxed at 20%. Everyone in the country has a £12,500 Personal Allowance. A transfer of £1,250 of the Personal Allowance will enable you to save £250 income tax on your income. This transfer is called the Marriage Allowance.

  • Get a lodger, and charge him at least £7,500 per year

This level of income from a lodger is exempt from income tax.

  • Buy ISAs and Premium Bonds

Interest from ISAs and prizes from Premium Bonds are exempt from income tax.

  • If you have an asset that is likely to increase rapidly in value, give it away as soon as possible!

Giving away an asset, so long as you don’t put it into a trust, is what’s called a Potentially Exempt Transfer (PET) in inheritance tax terms. If you survive longer than 7 years then hey presto, no inheritance tax will be payable on the transfer at all. If you do sadly die within the 7 years, then the trick of PETs is that their value “freezes” at the date of transfer value for the purposes of inheritance tax. So, if you gave away a bitcoin worth £100 in 2015, and then you died in 2018 when the bitcoin was worth £15,000, your estate would be paying IHT only on the transfer of £100. The crucial point to this wheeze is that you have an asset that is likely to increase rapidly in value. An early gift of such an asset will also minimise your liability to capital gains tax which you pay when you’re alive (yes, gifts are chargeable to CGT unless made to your spouse. The relevant value to be taxed is the difference between the value at the date you acquired the asset and the market value at the date you gifted it. The “low-value” CGT exemptions are assets worth less than £6,000 on disposal, “wasting assets” such as white goods, and your principal private residence with grounds of up to half an acre).

  • If you have a vested interest in remainder (sometimes called, incorrectly, a reversionary interest) in a trust fund (properly called a settlement fund), which was created in any way before 22 March 2006 or alternatively created by someone’s death on or after 22 March 2006, then give it away!

“In remainder” means that your interest in the trust is held over until the death of another person who has a prior interest – they have “an interest in possession” (albeit only to the trust income), while you have an “interest in remainder”. The importance of how it was created in relation to 22 March 2006 is that life-interest settlements created as described above make the life tenant the deemed owner of the underlying settlement capital. You, as the remainderman, can give away your interest without any inheritance tax implications because you’re not treated as owning the underlying capital while the life tenant is alive. If the underlying capital is worth £1 million, you may prefer to give your entitlement to it away, rather than taking the entitlement, then dying within 7 years and having the £1 million form part of your estate for inheritance tax purposes. Or you may prefer to just take the million and spend it.

  • Take out a life assurance policy, assign the benefit of it early, and pay the premiums out of your surplus income.

If you’re married and are planning to leave your estate to your surviving spouse (and vice versa) then inheritance tax will be deferred until the last one of you alive dies, and inheritance tax charges will then kick in and so will both of your respective nil rate bands, currently £325,000 each, because you don’t use up your nil rate band if you leave your entire estate to your spouse. If this is the case, then you should take out a joint end-of-life assurance policy which pays out only once you’re both dead. If you’re not married, or don’t want to leave your estate to your spouse, then take out a life assurance policy just for yourself.

You can then place this policy (in either case) in trust for a named beneficiary. If you elect that they would be entitled to take the policy pay-out immediately that you die then it will be a bare trust – alternatively, you can place it into a discretionary trust with trustees who can then direct that it be advanced for the purpose of paying your inheritance tax bill at the end of the day. If a discretionary trust, then there may be a liability to pay inheritance tax on the trust in an anniversary charge every 10 years that the trust exists, and again when the trust comes to an end, and you will be charged IHT at 20% in your lifetime on the value of the trust when you assign it to the beneficiary – that is, 20% on the £10,000 value in the example below.. The benefit of this however is that you will be assured that the pay-out will be used against your IHT bill.

If you place it into a bare trust – simpler, and with no ongoing or exit IHT charges – then you will only be liable on your death for IHT on the value of the assurance policy on the date that you place it in trust, and then only if you die within 7 years of making the assignment. Your policy might be worth £10,000 while you’re alive, but then when you die it might be worth £100,000 as a pay-out, for example. If you die within 7 years of placing the assurance in trust and if you do not have any of your nil rate band available then you will pay IHT at 40% on the £10,000 on death, while your beneficiary will actually be receiving £100,000. If you don’t place it in trust then in such circumstances you would be paying IHT on the full £100,000 on your death because it would still form part of your estate. If you place it into a bare trust and live beyond the 7 years then there will be no IHT to pay on the £10,000. The biggest danger with this option is that the beneficiary dies before you.

Even though you place your life assurance policy into trust for somebody else, you will still be responsible for making the premium payments. If you ensure you make these payments out of your surplus income – it must be strictly income, and strictly surplus to your living needs – then these payments will be exempt from IHT even if you die within the 7 years of making any such payments.

So, in short, take out a life assurance policy, place it into a bare trust early (by naming a beneficiary with your life assurance provider), and then make the premium payments out of your regular surplus income.

Death in service benefits are like a life assurance policy but linked to your employment. Most of the time, these are discretionary – so that it is your employer (or rather, the trustees they appoint), rather than you, who decides who ultimately benefits from the pay-out when you die.

Such policies do not form part of your estate for IHT, and so it is advisable to request via a letter of wishes (entirely non-binding it must be said) that a loved one other than your spouse takes the benefit. Anything passing to your spouse under your Will would be tax exempt, whereas a gift to your daughter would not. As the death in service benefit in this scenario doesn’t form part of your estate there will be no IHT to pay, and it would be a waste from a tax-saving point of view if it wasn’t assigned to someone who would ordinarily incur an IHT liability under your Will – or who at the very least would eat into your Nil Rate Band. Think of this as a free gift.

As an example, assuming you’ve already used up your nil rate band when you die, if you leave £100,000 to your daughter in your Will there will be £40,000 tax to pay on that sum. If instead you have a death in service benefit held on discretionary trust and your employee chooses to act on your letter of wishes to give the benefit of it to your daughter, and if the value of it is £100,000, then your daughter will take £100,000 with no IHT on your estate on account of it.

  • If, on the other hand, you have death-in-service benefits for which the assignment of benefit is fixed according to your wishes, fix it so that your husband or wife is the beneficiary.

Such a benefit will form part of your estate for IHT, and so if you left it to your daughter as in the example above then the £40,000 IHT liability would still be incurred. A gift to your wife is exempt, and so it can pass to her with no IHT being incurred.

  • Support a loved one with regular payments from your surplus income.

Again, such payments are exempt from IHT even if you die within 7 years, and they won’t eat into your nil rate band. You could decide to support your niece through university and then with her rental payments, and then count that as a debt paid and not leave anything to her in your Will. These payments must be regular however – they are not gifts – and they must come out of your income.

Say, for example, you earn £50,000 per year, but you only use £30,000 to live on. Once you’ve dealt with other things (for example, perhaps the life assurance premium payments mentioned above, and gifts in consideration of marriage for example), you might decide that you could give your niece £250 a month to help her with her own living expenses. That amounts to £3,000 a year. If you then die 5 years later, that’s £15,000 you’ve given her. You will not pay any inheritance tax on that. If you had left her £15,000 in your Will instead, then at the very best this would eat into your nil rate band – and if you don’t have any nil rate band left then your estate would be paying £6,000 IHT on that sum!

You should make sure you keep records showing that these payments are being made regularly, and that they genuinely come from your surplus income. As the payments will be cash there won’t be any CGT on the transfers either.

  • Buy a working farm

The rules on Agricultural Property Relief may well soon change, so take care with this one. Broadly, however, if you buy a working farm, become a farmer, live on the farm and work it for at least 2 years until you die – make sure you die living on the farm though, whatever you do don’t go into a retirement home and don’t get so ill (before the moment of death) that you can no longer work it as a farm – then the farm will enjoy 100% relief to inheritance tax when you die. That’s a good saving, but you do literally need to work until you drop.

Alternatively, you can just buy a working farm and rent it to a farmer taking care that you are legally entitled to possession of the property within 12 months at any point. In these circumstances you’ll need to own the farm for at least 7 year and will only get 50% Agricultural Property Relief.

Also, make sure you don’t transfer the property to your spouse thinking that you are acting in accordance with one of these other wheezes, because that will start the 2-year or 7-year clock all over again.

  • Invest in unquoted shares

These are shares in businesses that are not quoted on the stock exchange. If you then hold these for at least 2 years then their value will be 100% exempt from Inheritance Tax when you die. Of course, when they are sold, either by you or someone who inherits them from you, then CGT will likely be due. However, CGT is 20% on gain, whereas if you had kept your money rather than investing in the shares then (assuming you have no nil rate band available) you would be paying IHT at 40% on the whole sum. Even better, the person who inherits the shares (or anything else, for that matter) will inherit it at the probate value – that is, the value on the date of your death, and it is with regard to this that CGT will be calculated.

If you have £100,000 in cash and no nil rate band then you will pay £40,000 IHT on that when you die (I think that we can assume that any interest you would receive on that figure to grow it would be minimal). If instead you spend the £100,000 on unquoted shares and die after 2 years, leaving the shares to your son with a probate value of £140,000, and he then sells them 6 months later when they are worth £145,000, then your estate will pay nothing in inheritance tax on this gift, and your son will pay only £1,000 in Capital Gains Tax. That’s a difference in tax between £40,000 and £1,000 on a gift effectively of £145,000. Of course, you have to invest well to get this result. Even if you don’t invest so well, and the shares don’t increase in value at all in the two years to your death, nor in the further 6 months that it takes your son to sell them, there will be no IHT and no capital gain. So this is the difference between £40,000 in tax and £0 in tax on an inheritance of £100,000.

If you already own unquoted shares and give them away in your lifetime, then the gift is a Potentially Exempt Transfer – but if you die within 7 years then they will still enjoy the 100% Business Property Relief. If they have already been sold by the person you gave them to, however, and you die within 7 years, then the gift will be treated as a cash gift and liability to IHT will arise. In the above example, if you gave the shares to your son just before you died and they were worth the full £145,000 at that time (still allowing you the two years of ownership), and if he sold them immediately, then when you died he would be paying Inheritance Tax on the £145,000 gift (that is, £58,000) plus you would already have paid Capital Gains Tax on the gain from £100,000 to £145,000 – and assuming you have none of your allowance available this will be charged at 20%, namely £4,500. In this scenario, on a gift of £145,000 there will be tax of up to £62,500, which is significantly more than any of the scenarios described above.

  • Give your husband or wife cash or so that they can use up their various annual allowances.
  • CGT annual allowance

The current Capital Gains Tax allowance is £12,300 – the amount of capital gains that you can accrue before having to pay tax on it.

Actions (that may) be written into your Will

If you have valuable assets which are likely to be sold by your beneficiary, and are likely to attract CGT charges, bequeath those assets in your Will – do not give them away as lifetime gifts (except to use up your annual CGT exemption, or unless there are compelling IHT reasons to do so).

Death provides a re-setting of the clock for the valuation of assets, and this can translate into some very healthy CGT savings. If you gift a valuable asset in your lifetime, you will pay CGT on the gain in value since you’ve held the asset. If you bequeath the asset in your Will instead, your beneficiary will only pay CGT on the gain in value since you died. Of course, it is fine to give away assets in your lifetime so long as your gain is within the £12,000 annual exemption. Also bear in mind that IHT is charged at 40% if you have no nil rate band left, whereas CGT will likely be 10 or 20% and won’t be higher than 28% in any event. So, if you have to pay CGT in order to avoid IHT then do it. Just be careful with what you’re doing.

Gift your unquoted shareholdings in your Will

It is tax inefficient to give away your unquoted shares during your lifetime. You should instead leave the qualifying shares as a legacy in your Will. To qualify for the tax saving you must have owned your unquoted shares for at least two years.

Whether as a lifetime gift or as a gift in your Will, a transfer of qualifying shares will always enjoy IHT business property relief of 100%. This is so even if you’ve made the transfer as a lifetime gift and  then go on to die within 7 years, so long as the shares have not been sold before you die. However, you can’t necessarily control whether your beneficiary keeps or sells the shares. There are significant reasons not just for IHT but also for CGT why you should not gift the shares in your lifetime but leave them in your Will instead.

Consider – George bought 5,000 unquoted shares in 1990 in a small computer company, together worth £5,000, and when he died in 2018 those same shares were worth £50,000. George leaves said shares in his Will to his son, who promptly sells them. There is no IHT on the legacy of the shares because of business property relief, and there will be no CGT payable either because they have been sold immediately at the probate value – as we know, death re-sets the clock of valuation for CGT purposes.

Contrast this with a lifetime gift. If George gifts the shares to his son then first of all George would be paying CGT on the gain in value from £5,000 to £50,000. If we are generous and assume that the shares qualify for Entrepreneur’s Relief then George will be paying CGT at 10% – that is, £4,500. If the son again in this scenario promptly sells the shares, again for £50,000, then the gift he received from his father loses its IHT business property relief, meaning that if George dies within 7 years the £50,000 will be treated as a cash gift. At the very best, this will now eat into George’s nil rate band, and at worst – if no nil rate band is available – then an IHT charge will be incurred on the £50,000 at 40% – that is, £20,000.

Simply by comparing a legacy in a Will to a lifetime gift, we have jumped from a tax bill of nil to one of £24,500 across CGT and IHT.

There is a further advantage to leaving such qualifying shares in your Will rather than giving them as a gift in your lifetime. The requirement for at least two years’ ownership in order to qualify for the business property relief is strict. Ordinarily, on any transfer the ownership period will be re-set. However, if a spouse inherits the shares then she also inherits the ownership period from her husband. This is because an inheritance from one spouse to another enjoys the spousal exemption first and foremost, which applies to all property, and so it is deemed that the available business property relief has in fact not been used in such a transfer, and so it remains available to the second of the surviving spouses. Also for this reason, this assumption of the ownership period by a spouse does not take place if she has received the shares as a lifetime gift – in such a case, the qualifying ownership period is lost.

I’d say that notwithstanding any wizardry of trusts, the most tax efficient way to make a simple gift of qualifying shares is to bequeath them in your Will to your spouse, failing which in substitution to your son / daughter / some other beneficiary.

If you have some property which you want to leave to your son for example (or any other beneficiary who is not your spouse), then leave it in your Will to your spouse in the “hope” that your spouse will quickly pass it on to your son etc.

In this way, there will be no CGT payable on the legacy to your husband (because transfer on death is not a chargeable event for CGT), and there will be no IHT on the gift either because the legacy will benefit from the spousal exemption. If your husband then gifts the property to your daughter quickly then he will only pay CGT on the gain in value of the asset since its value on the day you died. So long as these steps are all done quickly then this will most likely be negligible, and will likely fall within your husband’s annual CGT allowance. Your husband would then need to survive the gift by 7 years so that no IHT is payable in respect of the gift from his own estate.

Make use of the spousal exemption

Gifts to your husband or wife are exempt from IHT. Sometimes testators will make a “mirror Will” with their spouse, typically one leaving everything to the other and then in substitution to their children.

Charitable giving

Any gifts to charity are exempt from IHT. In addition, if you give 10% of your estate – after liabilities have been paid out and after all exempt gifts (including gifts that make use of the spousal exemption, but not including the charity exemption) – then the rest of your estate will enjoy a lower tax rate of 36% rather than 40%. If you have a favourite charity then this might be worth it, but of course the greater the gift to charity to less there is available to gift to others. The rules for calculating the 10% are hearty and complex, but this broadly conveys the situation.

If you own the home you live in, leave it to your children or grandchildren in your Will.

Gifting your own home to a direct lineal descendent will trigger an additional nil rate band for your estate – currently an additional £175,000.

If you leave the home to your spouse (presumably he will be living in the house as well), then when he dies both your Residence Nil Rate Band and his can be activated, so long as the property is left to a direct lineal descendent.

Leave certain parts of your estate – possibly the residue – to your spouse on discretionary trust the benefit to your spouse for life, and the property then passing to your children.

This can give peace of mind, securing a chain of inheritance from your spouse to your children. It can also provide flexibility – if your spouse doesn’t need the use of some or all of the trust fund, she and the trustees can elect to end the trust, advancing the funds to your children early.

There are also tax advantages. There will be no IHT to pay on the creation of the trust because your spouse will be treated for tax purposes as owning the entire trust fund rather than just the lifetime use of it, and so it will benefit from the spousal exemption. If the trust is then ended early and advanced to your children then your spouse will be treated as having made a Potentially Exempt Transfer, and if she survives for 7 years then there will be no IHT to pay on it in respect of her estate either. As an Immediate Post-Death Interest (IPDI) trust it will also allow your Residence Nil Rate Band to be passed on, as well as your surviving spouse’s when she too passes on. Not many trust options permit this.

As an IPDI, there will be no IHT anniversary charges, which for most trusts are charged every 10 years. Any advances to the remaindermen (in this case the children) before the death of the life tenant will likely incur Capital Gains Tax.

Nil Rate Band discretionary trust

If your residuary beneficiary is your spouse, do not leave specific gifts to non-exempt beneficiaries “free of inheritance tax” – you should let your non-exempt beneficiaries shoulder their share of the tax burden.

The reason for this is that if you do the opposite – if you leave a gift to your son or daughter etc. “free of inheritance tax” – your estate will actually be paying more inheritance tax overall.

Typically, the beneficiary of a gift will be liable for the IHT on that gift, though the deceased’s Personal Representatives will deduct the IHT due before giving the gift to the beneficiary. If, however, the testator (the person who’s written the Will) has stipulated that the gift is to be free of inheritance tax then the IHT due on that gift will be payable from the residuary estate. However, you do not simply pay IHT on the value of the gift as though the gift had been subject to the tax. If that were the case, then a gift of £100,000 would incur an IHT charge of £40,000. But that is not the case.

What happens is that the gift which is free of inheritance tax is “grossed up” so that it is deemed to be some amount X such that after application of the 40% IHT charge to X you are left with a gift clear of IHT of £100,000. It is the tax due on X, not the tax due on £100,000, that is paid by the residuary estate.

In either case, if your residuary beneficiary is exempt (for example, is your husband or wife) then the tax bill will be lower than if the residuary beneficiary is not exempt – see the example under the next bullet point. Of course, also, if the specific legatee is exempt then the discussion is irrelevant because the specific gift in that case will not incur an IHT charge in any event. The trouble is simply that if you have an exempt residuary beneficiary and a non-exempt specific legatee receiving a gift free of inheritance tax then your overall tax position will be worse than if that specific legatee had shouldered their own share of the IHT burden.

In the case of the £100,000 gift. Say that you have no Nil Rate Band available when you die. You want to leave £100,000 to your friend Julie (it could equally be to your son or daughter), and the residue of your estate to your husband. When you die you have £200,000 in the bank and you own no other property.

If you gift the £100,000 to Julie subject to IHT, there will be a 40% charge, namely, £40,000, and Julie will receive £60,000 clear cash. Your husband, who is exempt from IHT and so pays no tax, receives £100,000. HMRC overall receives £40,000 in IHT.

If, on the other hand, you gift the £100,000 to Julie free of inheritance tax, this sum is grossed up to a deemed gift of £166,666.67, from which IHT of £66,666.67 is due to the Revenue. This comes out of the residue. Your spousal exempt husband receives just £33,333.33, while Julie receives the full £100,000. The Revenue receives £66,666.67 – i.e. nearly £27,000 more overall than if you had left Julie to shoulder her share of the tax. Julie, of course, is happy, as is the taxman. Your husband is less happy – and so is your son, who may be due to inherit from your husband’s estate in due course.

Clearly, the smaller the specific gift the less severe the IHT consequences – so in some circumstances you may wish to take the hit anyway. Just be aware of the consequences, especially when the specific gift is sizeable.

If your residuary beneficiary is non-exempt, i.e. not your spouse or a charity etc., think carefully before leaving a specific gift to another non-exempt beneficiary “free of inheritance tax”.

First of all, the amount the taxman gets doesn’t change in this scenario – from a tax saving perspective, the Revenue will get the same amount overall whether you leave the gift free of inheritance tax or subject to it, despite grossing up still applying. If the specific gift is small in comparison to the size of the residuary estate, then you may wish to leave the specific gift free of inheritance tax. But if it is sizeable in comparison, then be aware that the full IHT liability on both the residue and the specific gift will be born solely by the residue. If, in the example above, the residuary beneficiary was your son, not your husband, then the Revenue would be taking £80,000 in IHT overall whether you leave the specific gift of £100,000 to Julie subject to or free of inheritance tax. If subject to IHT however, both Julie and your son would be receiving £60,000, but if free of IHT then Julie would be receiving the full £100,000 and your son only £20,000 from the residue.


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