With planning it is possible to avoid bequeathing a hefty tax bill with the contents of your estate says Ron Wheatcroft
More people are seeking to avoid placing the burden of inheritance tax on their families by taking out tax-efficient policies to cover their future liabilities.
The whole life policy is most suitable. With married couples the plan is normally written on a second death basis, the transfer of wealth between spouses being exempt on the first death but liability being due when the second partner dies. Where there is no spouse, then a single life policy is appropriate.
Whole life plans may be unit-linked or with-profits and should be written in trust to provide the necessary funds outside the estate. Sometimes a low-cost plan consisting of a combination of whole life with profits and decreasing term cover is used.
Many products are designed on a flexible basis so that they can meet changing circumstances. The estate value will of course change when it consists of assets such as shares. Therefore an important feature of a policy whose proceeds meet IHT liability is the facility to increase the sum assured as the liability increases.
This may be in line with an index such as RPI or perhaps at a fixed rate. Premiums normally rise accordingly. The increases may take place irrespective of the state of health of the life assured at the time.
Life offices will restrict the ability of the policyholder to select against them and usually limit such options to those aged 65 or under at the option date.
Some life offices allow the level of sum assured to be increased without health evidence if an increase in the rate occurs.
The premium paid will normally be exempt from IHT either because it is payable out of normal expenditure or the u3,000 annual exemption.
Provided the donor survives for seven years from the date of the gift the value of the gift falls outside the estate. There is a sliding scale of IHT on gifts where death occurs within seven years. Decreasing term assurance cover should be taken out to meet the IHT liability for any gifts outside the annual exemptions.
Some simple measures can be taken to ensure that money ends up in the right hands. Most people want to provide a sum of money for their dependants in the event of their early demise. It is surprising, however, how many people do not use a trust with the result that the sum assured is aggregated with the estate on death. The trust enables beneficiaries to avoid the wait for probate to be granted.
Life cover can be provided through a pension arrangement. Under exempt approved schemes the trustees have discretionary powers.
It may be possible to use the lump sum group life payment together with a return of the employee's contributions to pay IHT liability, by using the discretion to pay the cash to those who have the responsibility for the tax.
Term assurance cover may also be written with a personal pension plan. The maximum permitted contribution is 5 per cent of net earnings and the benefits can be written subject to a trust. These plans are available to the self-employed and to those not in an occupational scheme. Some companies will only offer pensions term cover if a personal pension plan is taken at the same time but a number allow just the term cover. Tax relief is available on the premiums but any contributions paid into term cover reduce the maximum which could be paid into the pension.
Lump sum plans have been around for a number of years. One of the most popular is the 'back-to-back' plan. A single payment covers the first premium to a regular premium life policy and purchases an annuity with the balance. The annuity instalments then produce an income and pay future premiums into the life policy which is written in trust to replace capital expended on the annuity.
Care is needed to ensure that each part of the arrangement can be treated separately. This could mean using different life offices for each part of the arrangement.
A number of other lump sum plans are available. The structure varies but the intention is to allow a gift to be made by an individual while still retaining access to income or capital.
Inheritance tax planning must consider not only the most tax efficient means of transferring wealth between generations but also the need to provide adequately for the individual to live comfortably through his old age.
The products offered by life offices, such as cover for long-term care needs, can address this need.
Ron Wheatcroft is technical services controller with Mercantile & General Reinsurance.