Aviva Case Study – The role of Life Assurance in constructive IHT planning

Learning Objectives:

• To understand the inheritance tax and capital gains tax challenges that can result from lifetime gifts for those that wish to retain access to and control over their assets
• To appreciate and be able to articulate the simple tax effective benefits that an appropriate life assurance policy in trust can deliver as part of an estate planning strategy
• To understand and appreciate on a chronological basis the IHT treatment of a life policy in a discretionary trust 

Overview

With the nil rate band and the residence nil rate band fixed until April 2028, the impact of Inheritance Tax (IHT) will be significant for greater numbers of individuals.

Andrew and Anna Taylor are each aged 68 and have been retired for nearly three years. After successful careers in electronic engineering and nursing respectively, they both have good final salary pensions and full state pensions.

Alongside their full-time jobs, the Taylors have continued the family tradition of investing in commercial property and have done so for many years, building up significant assets. The yields from these investments also means that they retain more than reasonable cash balances.

Their pension and investment income comfortably provides them with an income surplus of around £2,000 each month which currently accumulates in their account, exacerbating their IHT liability.

Their total assets have now reached £2,000,000, resulting in a potential IHT liability of £400,000 on second death (taking account of two nil rate bands and two residence nil rate bands) and this seriously concerns them, especially given that the residence nil rate band will be cut back once the full value of the estate of a deceased, otherwise entitled to it, exceeds £2,000,000.

Objectives

The potential IHT liability of £400,000 is troubling for the Taylors, the thought of their family being taxed on their hard-earned assets is distressing to them. They do not wish to leave their children with such a liability and are interested in reducing this bill. However, they do not wish to introduce complexity into their lives and, especially given their ages, are keen to retain substantial control over, and access to the majority of their assets especially their main residence and liquid assets.

As stated above, the majority of their assets are held in their commercial properties, all of which have significant capital gains “baked in”. The Taylors had considered gifting one to two of the properties until they realised that making a gift would be treated as a disposal for full market value and so would result in a material, taxable capital gain. This is especially concerning when they were reminded that, under the law as it stands, the value of all potentially chargeable assets would be revalued on death with no CGT liability on death. In effect those who inherit would do so with a “clean slate” and a “base value” to measure future capital gains equal to that on the death of the person from whom the assets are inherited.

Even though lifetime giving in practice does not currently seem possible the Taylors have a clear objective to be able to pass all of their commercial properties (along with the rest of their estate) to the children on the death of the second of them to die undiminished by taxation.

Solution

The Taylors sought financial advice regarding their IHT concerns. Against the background of their concerns to retain substantial access to their assets and avoid triggering a CGT liability and given that both of them are in good health, their adviser recommended the consideration of using some of their surplus income to fund a guaranteed whole of life insurance policy written on joint lives “last survivor basis ( so the sum assured would be paid on the second death) , held in a discretionary trust.

Their policy sum assured will be set to cover the IHT liability arising on the death of the survivor of them and, on second death, the policy will pay into the trust and be used to fund the IHT bill. As stated, a joint life, last survivor policy, will only pay on the second of the Taylor’s death as this is when the IHT will fall due.

After running a quote, the premium is within their surplus income of £2000 per month. The monthly payments will be free of (effectively exempt from) IHT under the normal expenditure from income exemption as they have surplus income, the payments are made on an ongoing basis out of income and their standard of living will be unaffected by the payment of the premiums. This allows them to set their full nil rate band against their estates on death. The unused nil rate band of the first of the couple to die can be, effectively, passed on to the survivor – as can any unused residence nil rate band.

The recommendation provided by their adviser delivers a number of benefits to the Taylors.

On death the policy proceeds will be paid into the trust and provide the available capital pay the IHT liability on their death, ensuring the family (through the personal representatives of the deceased) will not need to find the funds, very likely through asset sales, to do so.

As the proceeds of the policy are held in trust, they would not be part of the estate of the deceased subject to probate and therefore available immediately for the beneficiaries.

The monthly policy premiums paid by the Taylors are guaranteed, ensuring there will be no future rises in cost, even if their health worsens in the future. However, it would generally be possible to increase the sum assured by inflation, with accompanying proportionate increases in premiums, to counter the impact of their asset values increasing. Clearly, regular review of the appropriateness of the sum assured should take place to ensure alignment with the expected liability.

The Taylor’s three key objectives are for their commercial property portfolio to be substantially passed on to the next generation undiminished by IHT for them to keep substantial control over their assets and to avoid triggering a CGT liability on the commercial property .

These objectives can be achieved with the suggested strategy. The whole of life policy will cover the IHT bill ensuring the family do not need to sell any property to pay the liability which can be retained in full and passed to the next generation. 

As stated above the large capital gain within the commercial property portfolio would be re-based on death with the beneficiaries inheriting the assets at the death value, giving them numerous future planning options if required.

In addition, the trust would not need to be registered until the death benefits had been paid, reducing the administrative burden for the trustees.

The Taylors were delighted with a solution which allows them to reduce their IHT liability and retain the commercial property portfolio for their children at what for them, was assessed to be a reasonable cost.