Inheritance tax (IHT) is one of the most hated taxes because it taxes your loved ones for possessions and investments that you have already paid tax on. In this Blog and next weeks, I’ll discuss some of the steps you can take now to mitigate it in the future.

What is IHT and will it affect me?

IHT is levied on your wealth, or estate, after you die. The tax is 40% on estates over the threshold of £325,000, known as the ‘nil rate band’. Your estate includes any property, possession, money, savings and investments you may have. Assets held in trust and even gifts you made when alive could all be liable for IHT.

Many people think IHT is only paid by the super-rich, but thanks to a decade of unprecedented house price rises even those with modest homes – especially in London and the South East – could see themselves fall into the IHT trap.

Unfortunately the IHT threshold has been frozen until 2014/15 although some argue that if the threshold had risen in line with inflation, each person would be entitled to a £500,000 nil rate band.

Some estates are completely exempt from paying IHT. Exempt estates include:

• Those valued at under £325,000
• Those where the deceased left everything to a spouse or a qualifying charity and the estate worth is under £1 million.
• Those owned by someone domiciled in a foreign country who died abroad and has a UK estate valued at less than £150,000.

If your estate qualifies as exempt you will need to fill in HMRC’s IHT205 Return of Estate Information form (known as C5 in Scotland).

How can I avoid IHT?

IHT is an unpopular tax but there are ways to arrange your financial affairs to minimise your bill, or even escape IHT altogether.

The impact of IHT is reduced by a number of exemptions and reliefs. It is important to understand the distinction between exemptions and reliefs.

• An exemption means that the transfer does not count as a chargeable transfer and is therefore neither taxed nor included in the cumulation for the future.

• A relief reduces the value of a chargeable transfer. It does not remove the transfer from the tax regime but merely reduces its value.

Can’t I just give my money away before I die?

A simple way to reduce your wealth for IHT purposes is to give your money away when you are alive. However, there are limits on how much money you can give away.

Gifting your money away falls into two categories: tax-free gifts and potentially exempt transfers (PETs).

Tax-free gifts include:

• Annual Exemption – you can give away gifts worth £3,000 each year and can also carry forward any unused allowance but only from the immediately previous year, ie. if you didn’t make any gifts in the previous year then you can gift £6,000.

Warning – if you don’t use it, you lose it.

• Those between spouses or civil partners who are both domiciled in the UK. If one party is domiciled abroad, the gift is capped at £55,000.
• Those to national institutions, museums, universities, the National Trust, small political parties, housing associations and amateur sports clubs.
• Those to people getting married. If you are a parent of the couple marrying you can gift £5,000, £2,500 if you are a grandparent or other relative, £2,500 each between bride and groom or civil partners. Anyone else can give £1,000.
• Those made out of ‘normal expenditure’. If you can prove the money you are giving away is out of surplus income then it becomes tax-free. To qualify the gift must not reduce your standard of living and is not from capital. It must also constitute a regular spend so if you want to give away a little each month it is best to set up a standing order from your current account.
• Small Gifts – gifts of up to £250 at any one time for birthdays, Christmas presents etc.
• Gifts for maintenance of spouse, ex-spouse, civil partner or ex-civil partner. The gifts are also exempt if made to relatives who are dependent on you because they are elderly, infirm, children in full-time education.

Potentially Exempt Transfers (PETs):

PETs are gifts that do not immediately fall into the tax-free gifts category but could become tax free in future. A PET becomes an exempt transfer if the donor lives for seven years after gifting the money to the individual , organisation, bare trust or disabled trust.

However, if the donor dies within seven years the PET becomes a chargeable transfer and the person who received the PET will be asked to pay 40% IHT on it. The amount of tax is calculated using taper relief, meaning the older the gift, the larger the reduction in tax.

If the gift was made less than three years before death there is no reduction in the tax charge. For gifts made three to four years before death tax is reduced 20%; 40% for gifts made four to five years before death; 60% if made five to six years before and 80% if made six to seven years before.

If the PET that has become chargeable is fully within the nil rate tax band the tax will be nil but the donor’s IHT allowance will be reduced accordingly. For example a gift of £50,000 where the donor died within seven years would utilise £50,000 of the donor’s IHT allowance and so reducing the remaining allowance to £275,000.

Top tip: It is worth noting that if you wish to give 10% or more of your estate to charity the rate of IHT for your whole estate (above the nil rate band) is reduced from 40% to 36%.

Next week we’ll conclude by covering other gifts, reliefs, nil-rate bands & actual payments.

Since their introduction in 1995, drawdown pension plans have been widely regarded as an alternative to the traditional lifetime annuity. Many welcomed the option to unlock tax-free cash without taking out an annuity while others were attracted to retaining ownership of the funds and the flexibility of the policy with regards income levels and lump sum death benefits. Arguably, the use of drawdown plans peaked in 2007, which coincided with the FTSE 100 Index hitting a high of 6,730 during June 2007. Five years on and Summer 2012 will see many clients approaching their fifth anniversary and their first formal maximum income review, and many may well be in for a shock.

Downward Pressure

So what has happened during the past five years to cause significant downward pressure on the income available from drawdown policies and what options are available to those clients looking for a simpler solution to their retirement income needs while maintaining a degree of flexibility?

Since 2007, stock market-linked investments have experienced dramatic fluctuations in their values. Shortly after the highs of June 2007, the impact of the banking crisis and the credit crunch took hold and the FTSE 100 fell to a low of 3,512 in March 2009. Although the FTSE has steadily recovered since then it still remains around 10% lower than it was in 2007.

April 2011 also saw the coalition government alter the GAD tables to reflect changes in life expectancy and, as a result, the maximum income from drawdown plans was reduced from 120% to 100% of GAD. In addition, over the past five years, 15-year gilt yields gradually fell from around 4.5% to 2.5%, thus reducing GAD rates further.

To illustrate the impact, for a male aged 65 with a pot of £100,000 in July 2007 the maximum income drawn would have been £9,250 per annum. On the same basis today the maximum income is £5,500 per annum.

For clients reliant upon their income and who have continued to draw it, the downturn in investment performance combined with changes in legislation and a drop in GAD rates have all contributed to lowering the maximum allowable income.

Most clients approaching the fifth anniversary of their drawdown plan will have to face the reality that their annual income will be significantly lower now compared to what they have relied on for the past five years.

Alternative Strategies

Although invested funds have not had the best ride over the past five years, I still believe a diversified portfolio built around equities will offer the best long-term solution for those who require an income in retirement, but also one which can potentially rise to hedge against inflation.

Pension Plans to Look Out For

Some of the plans being considered for our clients include Prudential’s Income Choice Annuity (ICA) and MGM’s Flexible Income Annuity (FIA). Both policies have similar benefits in that they offer a simplified investment proposition, a guaranteed income for life, potential to obtain a higher income compared to both conventional lifetime annuities and drawdown and to build in a spouse’s benefit.
Both offer minimum and maximum income bandings, which the client can choose an income between, while having the security that their income can never fall below the minimum. An added benefit is income levels can be further enhanced by taking into account the client’s (and that of the spouse’s) health and lifestyle status.

Other such strategies include Aviva’s Fixed Term Annuity (FTA) – a five-year plan which, on maturity, returns a guaranteed fund. As this is the minimum that can ever be returned, there are never any nasty surprises. However, a major difference compared to other FTAs is that there is the potential for capital growth and for the maturity value to increase if the underlying fund performs well.

On maturity, the client then has the opportunity to review their retirement options again based upon their prevailing health status, personal circumstance and market conditions at the time. This may allow them to secure a more competitive income or result in a restructuring of benefits such as inclusion or removal of a spouse’s pension due to changes in their personal life.

Clients who are in drawdown and are approaching their fifth anniversary will want to explore their options. A suitable solution that provides a higher income coupled with the potential for growth, but without the risks of drawdown? Now could well be the time to take a look at ‘third way’.

Relevant Life Policies

Whether or not you currently have life assurance, now is the perfect time to review your situation and see if you would be better off with a Relevant Life Policy.

What is a Relevant Life Policy?

A Relevant Life Policy is a single life plan, taken out on the life of an employee by an employer to provide death in service benefits. They are designed for individual members who may require life cover over and above that of the main company scheme already available to them or, where the number of employees is too low for a company group scheme.

These plans are restricted to providing life cover only and can not contain any waiver, critical illness or income protection benefits and must cease before the client’s 75th birthday. The policy premiums are paid in a more tax efficient way by the employer compared to employees paying for their life cover benefits personally.

The good news is, directors working day to day in a business are likely to qualify as employees so they can benefit from this possible cheaper way of providing life cover.

Why take out a Relevant Life Policy?

The company can make the payments, usually as an allowable deduction without them being treated as a
benefit in kind, which means:

• The policy premiums are treated as a business expense and are likely to be an allowable deduction against Corporation Tax for the employer

• These policy premiums don’t form part of an individual’s annual or lifetime allowance.

• There is no liability for the employer or employee to National Insurance on the policy premiums

• There is no liability for the employee to Income Tax on the policy premiums

• Life cover benefits are paid tax free to the nominated beneficiaries

Let’s now look at this in practice

Mr A is a shareholding director of SDL Ltd. He currently pays for his life assurance personally at a cost of £200 per month out of his post tax salary. As Mr A is also a business owner, we will look at both his personal and business costs and the effect of taxation of providing this cover.

Mr A is a higher rate taxpayer, he pays 40% Income Tax on the higher part of his salary. He also pays the additional 2% rate above the upper earnings limit for National Insurance. We have assumed the policy premiums for his plan are taken from his higher marginal rate of tax and have used these rates in our calculation. SDL Ltd pay employer’s National Insurance contributions at the “contracted in” rate of 13.8%. In this example salary, National Insurance contributions and Relevant Life Policy premiums are all treated as allowable deductions for the purposes of Corporation Tax.

Mr A paying personally for life assurance

Monthly premium paid from his post tax income.
= £200pm

Pre-tax income needed to fund £200 at Income Tax rate of 40% and employee National Insurance at 2% additional rate.
= £344.83

Employer’s National Insurance contributions at 13.8% on this amount of salary paid by SDL Ltd.
= £47.59

Total cost to SDL Ltd and Mr A
= £392.41

Less Corporation Tax at 20% as an allowable deduction. Salary, Income Tax and National Insurance are allowable expenses against Corporation Tax.

Total cost to Ali and SDL Ltd
= £313.93

SDL Ltd paying for a Relevant Life Policy

Monthly policy premium paid by LBD Ltd.
= £200pm

No Income Tax, employee’s or employer’s National Insurance payable.
= £200

No employer’s National Insurance contribution.

Less Corporation Tax at 20% as the plan is an allowable deduction.

Total cost to SDL Ltd
= £160.00

Mr A paying personally costs him and the business £313.93pm

SDL Ltd paying through a Relevant Life Policy costs £160.00pm

A saving of £153.93pm or a saving of over 49%.

Junior ISA will also be available for those under 18 and into these it will be possible for parents, grandparents or anyone else that is so inclined to save up £3,600 each year for the child with all the same tax advantages as for its bigger brother.

It goes without saying, risk tolerance and time horizons are important in helping decide which combination you choose. Please bear in mind that ISA allowances expire at the end of a tax year and any unused allowance does not roll over to the next; it is lost for good. It’s a case of use it, or lose it. ! ISAs are flexible enough to allow both lump sum investments and regular contributions, and we think that it is fair to say that most of the well known and highly respected fund mangers and economists now agree that Stock markets are priced very cheaply and there is an expectation that prices will start to rise steadily in the coming years to bring their valuations back to a more normal historic level. Investing in a stocks and shares ISA could help you to take advantage of this situation.

Benefits of ISA’s

All of us can benefit from having an ISA, as after the tax year ends, your savings stay within the tax-efficient ISA wrapper which will be free of Income and Capital Gains Tax. There is little point in making a taxable investment return if you can achieve the same gain in a tax free way.

The problem for most people is deciding how best to invest their money!
Haven IFA ltd can offer you help and advice on how to select the right investments for your ISA funds from the whole of the market, irrespective of whether you are a cautious, adventurous or ethically minded investor Haven IFA can help select the right investments for you.

Click here to contact us!

Annuities are a case in point. By simply taking advantage of the ‘Open Market Option – OMO’
or, in other words ‘shopping around’, can potentially improve the level of income by upwards
of 25%, and those who smoke or in less than perfect health can see this percentage improve
further via specialist providers.

Simply finding the best rate is only one of the important roles independent advice fulfils.
Other questions to be answered include whether to take your tax free cash, now known as
Pension Commencement Lump Sum (PCLS), at the start and should a dependents pension be
included? Do I need to allow for inflation? Is a Guarantee appropriate? How often do I need my
income?

These are just a few of the important considerations taken into account during the advice
process and these will impact on the overall retirement income you are paid. And once an
annuity is put in place the terms cannot be altered.

Although an Annuity provides an income for life with a degree of certainty the fact that they are
relatively inflexible means that some clients need to seek an alternative.

For example, you need to consider if control of your retirement fund/income or how it is
invested post retirement is important. What is your tax situations as you go through retirement.
Or you would like to leave something to your beneficiaries upon your death. It may be a
combination of annuities and other options could be more appropriate.

The huge choice of solutions both within the annuity space and beyond, together with tax
considerations, death benefits and risk mean that independent advice when considering your
options is vital.

Being ready to comply could take over 18 months; the impact is more than just extra pensions’ costs.

For many organisations, addressing the new requirements will be costly and resource intensive. Early preparation will be essential to ensure requisite changes to systems, processes and communication materials are identified and addressed.

I am pleased to announce that Haven IFA Limited are offering a free of charge Seminar on the 29^th February 2012 for employers to help explain the changes and how best to prepare for them. Please see the attached NEST Seminar invitation to this event for further details.

Please book early as we expect the event to be popular and numbers are limited.

We would like to take this opportunity to wish all of our clients a very Merry Christmas and a prosperous New Year.