Jeremy and Deirdre Tax Case Study – watch out for IHT being paid twice
Jeremy and Deirdre are married with an adult daughter Sandra and three grandchildren. They are well off and wish to ultimately pass on their assets to Sandra and their grandchildren. They have Mirror Wills in place which leave everything to each other and then to their daughter.
Jeremy and Deirdre own their home jointly and have other investment assets that give them an estate valued at £2 million each.
When Jeremy dies, his estate passes to Deirdre in its entirety. As it is a transfer to a spouse, it is exempt for IHT purposes and no IHT is payable.
Going forward 2 years, Deirdre dies leaving an estate worth £4 million to Sandra. The estate can utilise the full married couple allowance of £650,000 which leaves an estate of £3.35 million to be taxed at 40%.
So, on Deirdre’s death, the IHT payable is £1.34 million.
Sandra inherits £2,660,000 which she maintains during her lifetime and when she dies, she leaves it to her children in equal shares.
After deducting the Nil Rate Band, Sandra’s estate will be taxed at 40% and will pay IHT of £934,000.
This is the same money that Sandra inherited from her parents and on which IHT has already been paid.
In fact, between Jeremy, Deirdre and Sandra’s estates a total of £2.274 million in IHT has gone to HMRC, leaving the children/grandchildren with just over £575,000 each.
This isn’t what any of them had in mind when they drew up their Wills – it was not their intention for HMRC to be the biggest beneficiary of their estates, and the right kind of estate planning and use of Trusts could have stopped this happening.
THE LEGAL BIT – YOUR DEATH AND MITIGATING THE TAX BURDEN FOR YOUR FAMILY
For many people, it’s really important to be able to pass on as much of their hard-earned assets to their children, as well as making life easier for their grandchildren and future generations if they can.
A study carried out by a UK insurance company this year has found that over £400 billion in wealth being held by grandparents is set to cascade down through the generations. Initially it will pass to the “Baby Boomer” generation – their own children – and then it is likely that most of the Baby Boomers will pass some or all of this inheritance on to the next generation.
These Millennials are set to benefit from their share of the inheritance partly because of the particular financial challenges they face. They are finding it much harder to get onto the property ladder, to achieve similar wages and pension benefits than the previous generations, so many grandparents and parents want to help to make up for these differences in life opportunities.
Many people passing on their wealth in this way are hoping to pay as little Inheritance Tax (IHT) as they can so that they can maximise what they pass on. Mitigating payment of Inheritance Tax entirely is not easy to do and, even if it is possible, it’s an expensive exercise that tends to be counter-productive for the majority of people.
Mitigating the IHT burden
There are, however, some measures that you can take during your lifetime to ease the IHT burden, such as:
- Taking advantage of your annual gift exemptions which allow you to give away money every year without being liable for IHT.
- Giving money to children or grandchildren as wedding gifts.
- Using life assurance policies written in trust to meet IHT liabilities.
- Giving assets away – although this should only be done with caution and proper advice.
- Writing a Will that leaves a proportion of your estate to charity.
Another effective way to mitigate IHT is through the use of the right kind of Trust. Trusts have long been seen as the preserve of the aristocracy and the wealthy, but setting up a Trust is a completely legitimate form of estate planning which is available to anyone.
Furthermore, it is not unusual for assets to create an IHT liability more than once when they are being passed down through a family. This can happen when a grandparent, for example, passes assets onto their children and IHT is payable on that transfer. If the assets are still above the nil rate band when they are then passed onto the next generation (ie the grandchildren), the inherited wealth will be subject to payment of IHT again, and so on (see the Case Study above). In this way, IHT can be paid more than once on the same assets.
Leaving assets to someone through a Trust mechanism can prevent this situation from occurring and allow assets to be passed down the generations without attracting further payment of IHT.
Probably the most high profile example of this is the Grosvenor family – headed up by the Duke of Westminster. When the 6th Duke died in 2016, the family property fortune was estimated at £9 billion. The IHT bill for this size of estate would normally be in the region of £3 billion, but thanks to a Trust structure set up in the 1950s, the family is able to avoid paying this enormous figure.
This is because the family assets are held in Trusts and successive generations of the family are “trustees” rather than direct owners of the assets. What this means in very simple terms is that since the family don’t own the assets outright, those assets won’t form part of their estate for IHT purposes and therefore no IHT is payable.
Although the rules have changed considerably since the 1950s, you can still put assets in Trust in order to take them outside of your estate, or make provision in your Will to take advantage of legitimate IHT mitigation measures.
In addition to mitigating IHT, Trusts can have other advantageous uses in family situations such as:
- Protecting the interests of a family member who is disabled.
- Protecting children from being sideways disinherited when a surviving parent remarries.
- Protecting your children’s inheritance from 3rd parties such as ex-spouses and creditors.
Our advisers can look at your requirements and advise you on the best way forward for you.
Please don’t let this kind of thing happen to you. This scenario, and the pain that comes with it, can be avoided by putting in careful estate planning measures such as the ones recommended by our expert Estate Planning Advisers, so contact LPA Guardian to see how we can help you.
As with a lot of estate planning generally, it’s better to put these measures in place sooner rather than later and our expert advisers can explore the best way forward to achieve your aims.