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The good, the better and the ugly. Julie Wilson advises on two inheritance tax planning strategies and warns about a little-known trap

The government takes over £5 billion in inheritance tax every year. That’s tax on assets that have already been taxed.  I think inheritance tax is simply wrong. Particularly because rising house prices mean that ordinary people are getting caught by it.  And it was never meant to be a tax on ordinary people. 

Conservative MP Liam Fox said: “We must end the iniquitous multi-taxing of the same money.  It is not right to tax peoples’ incomes, then their savings from that income, to tax the movement of assets through capital gains tax, stamp duty and then tax them again through inheritance tax if they have the audacity to die.”  I agree. 

The late Roy Jenkins MP said: “Inheritance tax is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.”  

It’s voluntary because there are simple steps you can take to avoid it.  So why don’t more people do something about this grossly unfair tax?   I think it’s mostly because people don’t plan.  And why don’t they plan?  In my experience people are afraid of losing control of their assets.  Afraid of doing something wrong.  Afraid of running out of money.  Fortunately, many of my preferred solutions let people keep access to and control of their money.  I’ve saved my clients literally millions of pounds of tax using tried and tested ‘have your cake and eat it’ solutions.  

Here are two of my favourite inheritance planning tips:

The good

Inheritance tax-friendly ISAs are little known but are great ways to avoid that 40% tax.  These ISAs utilise Business Property Relief to exempt them from inheritance tax.  They invest in very small illiquid companies.  So they are perceived as risky.  But then so is a 40% tax hit.  They’re not for everyone.  But for people willing to accept the risk in exchange for the tax benefit, they work really well.  Some schemes even have an element of protection against the downside risk.  This works well for people who want to do something about their inheritance tax problem but also want to sleep at night.

The better

A deed of variation is a simple, tax efficient strategy that can help avoid 40% inheritance tax.  It isn't used nearly as often as it should be.  Here’s how it works. 

Say someone has already got an inheritance tax problem.  Then they inherit a decent sum from an elderly relative.  That new inheritance would normally suffer 40% inheritance tax.  But that additional tax could be avoided with a deed of variation. It is perfectly legal. It effectively ‘rewrites’ the will of the deceased relative to direct the inheritance elsewhere. 

Sometimes, the original recipient is willing to forego their inheritance altogether, for example, by directing it down a generation to children and/or grandchildren.   More often, though, it’s directed into a trust.   The original recipient of the inheritance can be a beneficiary of that trust.  Some advisers think this would get caught out by the ‘gift with reservation’ rule.  This rule states that you can’t give something away whilst still retaining access to it. 

I’ve seen a lot of clients who think they’ve sorted an IHT problem because they gifted half their house to their children.  But if they still live in the house, it won’t work.  Because it’s a ‘gift with reservation.’  The deed of variation avoids this problem because the gift is deemed to have been made by the original donor, who has died and can’t retain access to it, not the beneficiary who is redirecting the gift.  So it simply avoids that next wodge of tax that would ordinarily become due.  There are strict rules and it must be done within two years of the death.  But it is simple, quick, and effective.  For me, it’s often a no-brainer.

And the ugly

Yes, there are traps in inheritance planning.  That’s why some people fear to even make a start.  But with proper advice those nasty snares can be avoided.  Here’s one: the discretionary will trust.  First things first: people write a will.  Very good.  And then to avoid things like care home fees in later life they set up a trust within the will for half their house to go to children on the first death (of a couple).  All good so far, but here’s the trap.   AKA the law of unintended consequences.  A new inheritance tax allowance, worth £175,000 by April 2020, is now available.  It’s claimable by people leaving their main residence to direct descendants.  But because the will trust leaves half the house to the trust, that’s not a direct descendent (even if the beneficiaries of the trust are).  This could scupper the new allowance.  It’s really easy to re-write the will.  And of course, one could always unravel it with a deed of variation!  There are some circumstances where a nil rate band trust could still be beneficial.

Trusts can be brilliant in keeping tax bills as low as possible - and who doesn’t want that?  But the rules around them are super-complicated and not for amateur dabbling.  So the answer is not to do nothing, but to get some proper advice tout suite.  Because one day it’s going to be too late.

Julie Wilson is chartered financial planner and director of PenLife Associates www.pen-life.co.uk

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