The Ultimate Recycling: re-using your tax allowance in future generations

Following the budget in July 2015, Inheritance Tax (IHT) should only be paid on estates in excess of one million pounds

Since 2007 it has been Conservative Party policy that Inheritance Tax (IHT) should only be paid on estates in excess of one million pounds. Following the budget in July 2015, this will become a reality but only for certain people and staggered until tax year 2020/21 and only in respect of property passing ultimately to your children or stepchildren and their children. It will not apply to property passing to wider family such as nephews and nieces.

However, in the meantime, action can be taken to reduce the impact of IHT just by a bit of old fashioned tried and tested tax planning. The initial response by the then Labour Government was to introduce the concept of the transferable Nil Rate Band.

How does the Transferable Nil Rate Band work?

Currently each individual has an IHT allowance of £325,000 and thus the amount up to this figure is called the Nil Rate Band as it pays tax at 0%. Assets above this figure can suffer IHT at 40%.

So, with spouses and civil partners if one passes their estate on death to the other, on the death of the second they can double up their allowance to currently £650,000. That can be either outright or for life. However the potential problem with this is that if the survivor receives all the assets and they are subsequently admitted into residential care, then if all the assets are in their name, all of those assets are potentially at risk of being assessed towards the costs of their care.

Care considerations aside, there is another potential problem going forward for the wealthy that are affected by IHT. The effect of the transferable Nil Rate Band is that whilst the survivor can double up the allowance on their death if their family want to do some post death tax planning, they only have one tax allowance to play with. The first tax allowance has effectively been lost.

The ability to collect IHT allowances, coupled with a trust period of 125, can have a significant impact on reducing a family’s ongoing IHT liability via the use of trusts. Every death represents an opportunity to collect another IHT allowance which can be used to benefit successive generations.

So how can you take advantage of this?

By thinking strategically and considering not just one but successive generations. By taking a leaf out of the pre Transferable Nil Rate Band tax planning, under which, the only way to ensure that the two IHT allowances were available on the second death without passing assets on first death down to the children, was to leave the first Nil Rate Band in a trust created in their will.

The Executors would pass the Nil Rate Band down to the survivor who would then promise to repay the equivalent value back to the Trustees of the trust. At the end of the exercise the survivor would receive the Nil Rate Band but on their death the debt would reduce the size of their estate thereby ensuring that both allowances were used. Debt/Charge Schemes (as they were called) were a Revenue accepted way of achieving what the Transferable Nil Rate Band now does.

This tried and tested method can be used to divert an inheritance into trust and have it lent back to you. That represents the Holy Grail of tax planning; use of an asset during your lifetime whilst not paying tax on your death. The effect is to use that tax allowance again. Once repaid to the trust it can then be lent to the next generation, returned and lent again during that 125 year trust period.

What should you do with your will?

For the wealthy, this means going back to Nil Rate Band trusts again and on first death leaving the Nil Rate band to the survivor for life, thus enabling the survivor to double up on their death, but thereafter the Nil Rate Band returns to the first estate to be held on trust which enable it to be lent down to the next generation. If the survivor’s will also leaves their Nil Rate Band on trust on their death, going forward two IHT allowances can become available to successive generations. If the next generation also enable their IHT allowance to be made available in this way then those successive generations can have a significant hedge against future IHT liabilities during the life of the current trust period.

This can work for all families not just those given special treatment under the latest budget.

If you want more information on the Ultimate Recycling please contact Henry Anstey or Paddy Appleton from the Probate Team on 01733 882800.

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This article has been prepared for general interest and information purposes only; it does not constitute legal advice and should not be relied on as such. While all possible care has been taken in the preparation of this article, no responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by the firm or the authors.