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How £9bn in wealth was passed on without an IHT liability

Flexible discretionary trusts are the tax planners’ best kept secret, says Paul Wilcox, chairman, WAY Tax and Trustee Advisory Services.

When I started out as a young financial adviser, we had recently experienced a development within our sector from the traditional insurance salesman to the more sophisticated financial adviser. This was, of course, the 1970s when we moved from a combination of protection (term or whole life policies – on life and/or health) and blunt, ‘what you can afford’, savings strategies (with-profits endowments and pension products) into the era of factfinds and attempting to alert clients to what financial vagaries might await them over their prospective futures and then match solutions to those likely events. I remember it well and it developed into what was, mainly, a modular approach to financial planning. This worked extremely successfully for many advisers and their clients – if they had a realistic approach to their current and future financial lives. Matching strategies to school fee planning, house purchase, retirement and so on became a central theme in the financial planning process.

Throughout this time there was, however, a parallel universe which existed for more wealthy people who were being advised, not by the nascent IFA sector, but by private client lawyers, private banks and family offices. Last year saw the demise of the Duke of Westminster, who it was widely reported died leaving some £9bn+ of wealth but miraculously without any Inheritance Tax liability. The strategies used for his family primarily relied, not on insurance or pension contracts, but on the intelligent use of discretionary trusts.

So, what points am I making here? There are two issues which arise from these two apparently unconnected thoughts:

• The modular approach still applies to much financial planning, such as pensions for instance. But a more universal and highly flexible strategy, using flexible discretionary trusts to hold family assets, can serve clients far better with solutions for a whole range of issues. If there were any requirements from the Duke’s greater family group which involved cost, then the discretion within his family trusts meant that property needs, health costs and just about any event – predicted or catastrophic – could be met by the trustees.

• Establishing a trust, especially for the main purpose of managing Inheritance Tax (which is only one of many important benefits of such legal instruments) seems to have become inextricably, and inexplicably, connected with the insurance industry. Such trusts are generally far better established as independent legal entities with no specific ties to institutions (whose futures and future management are, in any case, always uncertain).

This neatly brings me back to the challenges of a modular approach in the face of far more contemporary themes that have evolved in the ‘noughties’. Let’s talk about messy divorces – one’s own or more especially our childrens’ – business failures, expensive illnesses within the family needing non-NHS intervention, maverick children’s (or children-in-law’s) overspending or habits with suspicious substances, long term care and so on. Of course, this non-exhaustive list is a list from hell and most of us will not experience too many of these issues. BUT the poor financial planner is often asked to consider these kinds of fears by wealthy clients. Furthermore, these fears are regularly cited as reasons why clients are reluctant to pursue advance strategies for tax-effectively passing on their assets to their heirs.

Use it or lose it

I am not talking about provincial post offices here, I am talking about the recurring and 7 year re-usable Nil Rate Band (NRB) for Inheritance Tax. Every individual taxpayer can remove up to £325,000 from their taxable estate every seven years, after the elapse of which time that gift is permanently removed from subsequent calculations for Inheritance Tax. This means that a 70-year-old individual, with a normal life expectation, can anticipate being able to painlessly remove at least £1m from their taxable estate without any personal Inheritance Tax liability. However, just like an annual ISA or Capital Gains Tax Allowance, if this important tax break is not used it will be permanently lost. So, make sure that clients use this great tax break – if they can.

Let’s return to the flexible trust issue for a moment. Clients are not well-advised simply to gift assets directly to their children to use this tax break, for obvious reasons – total lack of control moving forwards and an inability to then resolve any family issues which arise in future. This allowance should very often and most appropriately be used by making a chargeable (at nil) gift of the NRB into a flexible discretionary trust, where trustees can protect that family’s future security. Those trustees, if trusts are very carefully drawn, can make appointments and loans as appropriate and necessary, as well as cover such unanticipated personal needs as medical or later life care costs. The settlor will also have a permanent influence into future trustee decisions via ‘letters of wishes’.

There have been several moves to tighten the rules on the use of flexible trusts over recent years (for instance gifts into such trusts were, until 2006 considered to be PETs – potentially exempt transfers – and thus unlimited in size but have recently become chargeable transfers, and hence limited to available allowances) so there is every reason to get on and make use of the NRB as soon as is possible ahead of any further changes. Once such gifts are made the benefit is secured and future legislation will not impact them. Trustees can then oversee perfectly conventional risk-rated investment strategies going forwards, even keeping trust assets in cash funds if so desired.

Just as with the Duke of Westminster, if appropriate trusts with appropriate powers are established, this strategy leaves the trustees with Inheritance Tax efficient funds available to cover whatever of life’s vagaries overtake that family. Then on the demise of the Settlor the assets remaining within those trusts can be passed to beneficiaries by appointments or loans, to whichever surviving beneficiaries will benefit most and at whichever stage is considered best (such trusts have a flexible life of up to 125 years making tax-efficient generation skipping a possibility).

Flexible discretionary trusts for the husbandry of investment assets is often the next best thing to a financial panacea, especially for older clients worried about their uncertain future. This is an area of increasing interest for the skilled financial planner.

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