Seven-year hitch

I met two new clients recently with fairly similar ages and circumstances. They were quite wealthy, having received an inheritance, and their bequests had already borne inheritance tax (IHT) on the death of their parents. Both clients knew the sum would bear more tax when they died.

But the similarities stopped there. Although the first client received their inheritance earlier this year and saw me recently, the second had waited for a little over two years to do so.

A lot of people delay their financial planning, but although unnecessary delay is probably bad in general terms, there is a specific reason not to postpone action after receiving an inheritance. The reason is a two-year window after a death, which gives a one-off opportunity to use a planning device known as an instrument of variation.

The main way to avoid inheritance tax is to give assets away, of course, and this chimes with the client's wishes: they don't need the money and would prefer to use it for the children and grandchildren. The obvious choice for both clients is to establish a family trust to benefit further generations, which allows the gift to be made now but the clients (also acting as trustees) to control who gets what, when.

For the first client, who delayed, there is a seven-year waiting period before the money is out of the estate and free of IHT. Not only that, but the gift is irrevocable: she can never access the money again, no matter how circumstances might change in the future.

The second client, who took earlier action, was able to use an instrument of variation to rewrite her parent's will, making the new family trust deemed to be established by the will, not by her. The difference is that there is no seven-year waiting period (it escapes IHT from day one), and perhaps more importantly, it means that our client can also be a beneficiary of the trust.

So, if they ever needed to, they could decide to pass some (or all) of the money back to themselves. It's a rare example of being able to shelter money from IHT while still retaining access to it.

Long-term investments

On receiving the money, the family trust could make a range of long-term investments, the selection of which would depend on the client's preferred approach to risk and expected timescale for using the money. The trustees would have complete discretion as to how much, when and to whom any money was given out. The available beneficiaries would include children, grandchildren and perhaps other relatives and (for the client who didn't delay) the client and her husband as well. The trustees will be the client plus at least one or two others.

The investments held in the trust will still be subject to taxes to some extent. However, by understanding timescales, and the ages and tax status of the expected beneficiaries, and carefully choosing investment funds and investment vehicles, significant additional tax savings can be made - especially if benefits are to be used for the children (e.g. school fees) or other non- or basic-rate taxpayers.

So, the key advantages for the second client are that:

• using the instrument of variation will immediately remove the recent inheritance from the client's estate - saving up to 40 per cent IHT

• the client retains control over who receives any benefits from the trust - and this can include themselves; and

• keeping the money in the trust will enable future benefits to be provided to family members (notably the grandchildren) at very low rates of income tax.

Frustratingly, the client who delayed had missed the two-year window by as little as a few weeks.

 

Scott Gallacher is a director at Rowley Turton

He writes the regular IFA comment in Private Client Adviser