Neil Jones: Doubling down on estate planning principles

The current issues facing clients are neatly summed up in the immortal words of Robert Burns, who in ‘To a Mouse’ said, “The best laid schemes o’ Mice an’ Men. Gang aft agley, An’ lea’e us nought but grief an’ pain, For promis’d joy!”

The same challenges face our case study Barbara, who having already taken steps to put her finances in order now finds her best laid plans upended and is mightily concerned about the impact that the upcoming inheritance tax (IHT) changes might have on her retirement income.

She received an inheritance in 2016, which she placed in trust for her nieces and nephews, and has recently downsized her home to an apartment valued at £150,000 using the surplus equity to boost her pension. As a result, her pension is now £750,000, alongside Isa and cash savings of £125,000.

She has drawn up a will leaving her estate to her nieces and nephews, although her pension death benefit nomination is in favour of a long-time friend.

If Barbara were to die today, her estate for IHT purposes would total £275,000, comfortably within the £325,000 nil-rate band. In this scenario, no IHT would be due. But we know that from April 2027, when unused pension funds are brought into scope for IHT, her estate would rise to £1,025,000 leaving £700,000 exposed to IHT at 40%, resulting in a potential tax charge of £280,000.

Barbara’s scenario is just illustrative, but it reflects the real-life situations that many advisers are increasingly grappling with today.

With less than a year to go until the pensions IHT rule change, conversations I’m having with advisers suggest that mitigating IHT exposure and ensuring wealth is passed on efficiently remains firmly front of mind.

The knock-on impact is that advisers are having to weigh up where clients’ assets are best placed

And with good reason. Since the Pension Freedoms, pensions have increasingly been viewed as one of the most tax-efficient ways to pass on wealth, with few mainstream investments matching their benefits.

My feeling is we’re now well into the stage where discussion needs to shift from policy direction to the practical applications of the change.

Bringing pensions into scope of IHT tilts the board back to pensions primarily being a vehicle for providing a retirement income, which could mean other assets that were previously relied on for income are now available. The knock-on impact is that advisers are having to weigh up where clients’ assets are best placed.

Gift, insure, invest

In this new era of IHT, the order of taking retirement income will likely be turned on its head, with pensions being used first to reduce the chance they will be part of the taxable estate. Consequently, the other, non-pension wealth, needs to be made more IHT-efficient, replacing the benefit pensions are losing.

There is no magic bullet here, but in my travels the approach I have been reinforcing with advisers is ‘gift, insure, invest’

There is no magic bullet here, but in my travels the approach I have been reinforcing with advisers is ‘gift, insure, invest’. Each strategy will have different relevance for different clients, but focusing on these key areas remains an effective framework for reviewing plans, regardless of whether they are in the spending or saving phase.

That’s why I expect that lifetime gifting will take off in popularity, and solutions such as outright gifting or gifting into discretionary trusts adopted as an effective way to reduce the value of the estate, with an option of maintaining a degree of flexibility.

The reassurance for clients seeking different options is that these trusts are off-the-shelf products that are well established and familiar to advisers, having been used for years.

But other solutions should also be considered. The little-known normal expenditure out of income exemption also allows clients to gift any genuine surplus income they may have, such as annuity income or drawdown income, providing it’s regular income and doesn’t impact their standard of living.

Neil Jones: Spring Statement calm hides busy tax year ahead

A significant outcome is gifts can fall outside of the estate straight away without the need to wait seven years.

Insurance is a familiar approach for advisers too and involves putting in place a life insurance policy using a suitable trust to make sure the sum assured doesn’t sit within the estate.

Advisers should review their clients’ estates to establish which assets are likely to be retained, which will be gifted immediately, and which could potentially be gifted in the future. Essentially classifying assets with a red, amber, or green system.

For assets that remain in the estate, the IHT liability will also remain, so insurance products such as a whole-of-life policy might be considered to pay out and meet the liability when the last life assured dies. Some options may be limited for older clients or those in ill health, so it’s important that the cover is cost effective.

But let’s not forget investing where you might want to consider business assets and other investments that qualify for business property relief, such as AIM shares or closed company shares.

The increased level of risk applying to wealth that has been accumulated over many years will not be palatable

The rules around business relief changed in April, so it is worth balancing the higher level of risk these investments typically carry with the reduced relief now available. But for many, the increased level of risk applying to wealth that has been accumulated over many years will not be palatable.

However, the changing IHT landscape presents an opportunity to also ensure that clients’ assets continue to grow in tax-efficient wrappers, and as a result we’re already seeing this play out through a surge in demand for products such as onshore and international bonds.

Removing the income tax liabilities from a non-pension portfolio can help preserve tax bands and allowances for the pension income.

What still works

The ‘gift, insure, invest’ strategy can help clients avoid some of the potential pitfalls of poor decision making ahead of the pensions IHT change. Without proper advice, there is a risk people may deplete their funds too early or be left in position where they are unable to manage a large expense such as care costs.

Two out of five advised clients are concerned they may run out of retirement income

Research consistently shows that creating a sustainable lifetime income is the primary objective for clients’ retirement savings, and by focusing too closely on IHT they may lose sight of this.

Two out of five advised clients are concerned they may run out of retirement income, so it is not a good outcome to put a sustainable retirement at risk to avoid a tax they may not even be liable to.

There are still many effective planning tools, allowances and strategies that are available to support clients with estate planning, and when used alongside their objectives, they remain incredibly powerful.

Neil Jones is a tax and estate planning specialist at Standard Life