Andrew Haley: Do you ‘trust’ me?

With Financial Planner, Andrew Haley.

In 2006, the year Jack Dorsey sent the first ever tweet, the year Cannavaro lifted the World Cup for Italy and Gnarls Barkley’s “Crazy” was frustratingly inescapable, in the eyes of the law, I became an adult. But at the age of 18, I can’t say I felt much like one.

Fresh on my way to Newcastle University, I wasn’t exactly Martin Lewis when it came to managing my finances. If I had a fiver left by Friday, it was unlikely I’d still be holding on to it by Saturday which makes me wonder – if I’d have had access to a trust fund with thousands of pounds in, would it have been a good thing?  Would I have been less motivated and blown the lot before I graduated and lost some of the drive that steered me towards a career in financial services?

We don’t often consider this when we’re setting up that savings account for little Susie. Our intentions are positive and popping that regular deposit in her Junior ISA seems sensible. But will Susie be just as sensible as she turns 18 and takes full control of the account? Some families are able to go much further than the odd monthly deposit and may set up trust funds with significant values, but if set up on an absolute (or “bare”) trust basis, the beneficiary will have the right to access the fund in full once they reach age 18. There are other ways of dealing with this, however.

How best to pass on wealth to the next generation is one of the most common questions I am asked of late. It’s not a huge surprise when HMRC recently revealed that Inheritance Tax (IHT) receipts have reached £7.7 billion this tax year¹, IHT thresholds are frozen until April 2031, and pensions are due to form part of our estates for IHT from April 2027. Individuals have the £325,000 nil-rate band, which means a married couple can shelter £650,000 on second death. There is also the potential of the £175,000 nil-rate residence band when leaving your home to children/grandchildren, meaning £350,000 of the home value might be sheltered for couples, giving a potential £1 million threshold a married couple (although the residence nil-rate band does start to taper away for those with estates in excess of £2 million). Beyond these thresholds, IHT is normally payable at the rate of 40% on the excess.

So how might you tackle an IHT liability should you have one?

Spend it – One of the simplest (and most enjoyable) options is to spend it. If you spend enough to keep within the thresholds for IHT, then not only have you hopefully enjoyed some good times, but you can also potentially avoid having any IHT liability at all. A married couple could still potentially be passing on £1 million to their beneficiaries without issue.

Insure it – If you would prefer to keep control over your wealth and don’t plan to spend it or give it away during your lifetime, there is always the option of whole of life cover, where you pay an insurance premium for a payout on death. A couple might take out cover on a joint life second death basis in trust, covering the amount they anticipate they might have as an IHT liability. Whilst this doesn’t reduce the liability to IHT, it does provide a payout that your beneficiaries can use to cover the IHT liability.

Gift it – Rather than giving with a cold hand on death, many people prefer to give with a warm hand and see the benefit of the gift whilst alive. It can also be very beneficial for IHT planning to gift during your lifetime. Gifts of £3,000 per tax year are immediately outside of your estate and certain other gifts like wedding gifts (within certain limits) or gifts out of surplus regular income can also be classed as immediately outside of your estate. Other gifts made directly to individuals are normally considered a potentially exempt transfer and it starts the ‘7-year clock’. Potentially exempt transfers mean any tax payable on death may reduce if death occurs more than three years after the gift is made, and fall outside of the estate on death after 7 years.

You might gift directly to adults, but for children this might involve contributing to Junior ISAs, Premium Bonds or other saving/investment accounts. Keep in mind however the issue I raise of children then having access once they turn 18. The Junior ISA allowance is now £9,000 per tax year, and if you maxed this out each year for 18 years at a 6% compound annual growth rate, you would be handing them around £294,839 as they turn 18.

Trust it – Which brings us to the incredibly powerful planning tool of trusts. As I mentioned, an absolute (or “bare”) trust set up for a minor will be fully accessible by them once they turn age 18. Money paid into this trust is treated as a potentially exempt transfer and would fall out of the estate for IHT within 7 years. But the question is, “do you trust me?”. We might trust our children implicitly and have raised them with the values to be responsible adults, but sometimes life takes unpredicted turns. We all know friends and connections that had difficulties in their late teens/early twenties. There’s also often concerns around relationships breaking down and whether gifts might factor into divorce settlements.

This is where a discretionary trust offers greater means of control. A gift into a discretionary trust within £325,000 for any settlor (the person making the gift) means no immediate IHT issues – assuming no previous gifts into discretionary trusts in the relevant period. Above this threshold, the lifetime IHT rate of 20% is payable and there may be 10-year periodic charges depending on the trust value. The gift into trust gradually falls out of the estate over the 7 years, but crucially, no beneficiary has an absolute entitlement. Instead, the trustees (normally those who set up the trust – perhaps alongside others they trust) decide who benefits and when they benefit. Discretionary trusts can be set up in a wide range of different formats to suit the settlor’s preferences around control and access to capital or income. It is a complex area and certainly one where taking professional advice is strongly encouraged.

If you are considering how best to pass on wealth, mitigate IHT and make sure this is arranged in a controlled and considered manner, speak with your financial adviser or contact Active Chartered Financial Planners.

OR click here to find out more about Inheritance Tax Planning

¹ https://www.moneymarketing.co.uk/news/treasury-on-track-for-record-iht-haul-as-receipts-reach-7-7bn/#:~:text=Inheritance%20tax%20(IHT)%20receipts%20have,for%20another%20record%2Dbreaking%20haul.