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Inheritance Tax – How to have your cake and eat it!

July 2012

July 17 2012,
by Nick Plumb – (Plumb Financial Services)

Independent Financial Adviser, Nick Plumb of Suffolk based Plumb Financial Services, explains how it is possible to have a tax-efficient income from your investments whilst at the same time reducing the Inheritance Tax bill you will leave behind for your children.

Many people who have built up reasonable property and investment values are concerned about leaving an Inheritance Tax bill for their children when they die.  Equally, they cannot give away their capital during their lifetimes in order to reduce the tax, as they need the income it generates to help pay for the increasing cost of retirement.

One method of reducing the potential Inheritance Tax on an estate whilst still having access to investment income, is to utilise a Discounted Gift Trust.

During their working life, most people will build up savings and investment capital, often in tax efficient investments like ISAs and Unit Trusts.  When you stop working and retire, you will probably want those investments to produce extra income, to help fund your retirement. However, whilst you may have sheltered your investments from income tax and capital gains tax during your lifetime, when you die, it is Inheritance Tax that could be a major issue for your children or grandchildren.

The problem with most tax-efficient investments is that they belong to you. In other words, on death they are part of your estate.  ISAs, Unit Trusts, Bonds, National Savings, Shares, cash deposits, and even life insurance proceeds will all form part of your estate when you die.  If you die before retirement age, even your personal pension fund can form part of your estate, as can death in service benefits from occupational pensions.  Add in the value of a main residence, and many individuals could find themselves way above the current inheritance tax threshold of £325,000 or £650,000 for married couples.  Any excess above these figures will be subject to Inheritance Tax at 40%.

However, there is a solution. If you require income from your investments but are unlikely to ever need access to the capital, then you might consider a Discounted Gift Trust.

This is a special type of reversionary interest trust into which you make an absolute gift from your capital. The trust is written in favour of your children or other beneficiaries.  You can’t get the money back after it has been gifted into the trust, so this type of scheme should only be considered by those who have other cash reserves or easy access investments for emergencies.

Seven years after making the capital gift into the trust, the original sum (and any growth on it) will be deemed to have left your estate for tax purposes.  However, although the capital would no longer be part of your estate, you can still have a tax free income from it of up to 5% a year, potentially for the remainder of your lifetime.  When you die, the capital remaining in the Trust will pass completely free of Inheritance Tax to your beneficiaries. 

Even if you died within 7 years of setting up the trust, your beneficiaries would benefit from a ‘discount’ in the amount of inheritance tax that would be payable – hence why the schemes are referred to as ‘Discounted’ Gift Plans.

So, with a Discounted Gift Trust, you can reduce the Inheritance Tax payable on your estate, whilst still having a tax efficient income from your investments in retirement. 

In tax terms – you really can have your cake and eat it!

Nick Plumb is an Independent Financial Adviser and Practice Principal at Plumb Financial Services of Baylham in Suffolk.

The above article is provided only as a general guide and does not constitute specific personal financial advice.

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