An increasing number of UK expats are finding that their assets exceed the IHT threshold, but many are unaware that they can reduce or even eliminate any potential liability.
Many people have an inheritance tax (IHT) problem that, in theory, they can easily solve – all they need do is make substantial gifts and live for seven years, after which such gifts no longer form part of their estate for IHT purposes.
In practice, however, most people cannot afford this simple solution. They have investments that they rely on to generate income (and possibly capital gains) in order to maintain their standard of living. What they need to be able to do is remove investments from their estate but retain the ability to receive regular payments from them for the foreseeable future. But how can they achieve this without creating a gift with reservation or falling foul of the pre-owned assets tax legislation?
The simple solution is to use a Discounted Gift Trust.
As we have discussed, normally when making a gift into trust it would take up to seven years before it is free from IHT and you would not be able to benefit from or access the money. However, with a discounted gift trust, you and anyone else you have set the arrangement up with, if applicable, can benefit from the trust by receiving regular withdrawals.
The value of all these future withdrawals is called the ’discount’. It is calculated by the trustee, and agreed by the HMRC, taking into account factors such as your age, health and withdrawals required. The significance of the discount is that your estate should immediately be reduced by the calculated discount value.
Mr and Mrs Watt, aged 65 and 63 respectively, two children and two grandchildren own 1 house valued at £550,000, Antiques £30,000 and savings of £200,000
While little can be done to protect the portion of their estate held in property and antiques from IHT, they could protect some of their savings and investments by passing them down to other generations.
Their adviser recommends using £200,000 from their savings and investments to set up a Discounted Gift Trust.
To maintain their standard of living they set up the trust providing withdrawals of 5% of the investment, i.e. £10,000, a year. Based upon their age, sex, health and level of withdrawals, the ‘discount’ is considered to be just over half of the investment (£130,457). Assuming HMRC agree with the calculations then Mr. and Mrs. Watt’s beneficiaries has been saved at least £52,182 (40% IHT on £130,457).
As the above example demonstrates there are clear benefits of using this form of trust;
- You will normally benefit from an immediate reduction in the value of your taxable estate. This reduction is the ‘discount’ calculated according to your age, sex, health and level of withdrawals required.
- The remainder of your investment, the amount over and above the ‘discount’, will initially form part of your estate but will gradually fall outside of your taxable estate over a period of seven years – the period required for gifts to be no longer subject to IHT.
- You will receive regular withdrawals from your investment, which you can defer if necessary for up to five years.
This is just a simple example of the use of trusts and there are still a number of ways of reducing or even eliminating a potential IHT liability while generating an income and retaining a degree of control over the assets. However, IHT planning is a complex area and it is important to take informed, expert advice.
For further information, private and confidential, do contact any one of our financial Expat Experts listed on our expat expert directory page.