Rachael Griffin, tax and financial planning expert, Old Mutual Wealth walks through a case study which shows the effect of making multiple gifts for inheritance tax purposes and the impact on the order in which they are made.
Elaine and Paul Elwood retired five years ago and are now both in their early 70s.
Towards the end of his career Paul benefited from a series of large contracts – he worked in commercial property development – and Elaine unexpectedly inherited several hundred thousand pounds.
It meant the couple ended up retiring with significantly more wealth than they had expected.
They own their home, and with an estate worth around £1 million and a sound retirement income plan, they were able to pass some assets to their children, Molly and Helena, both in their late 20s with young families. They did this by placing £400,000 in a bond policy held in a bare trust. The gift into the trust was a potentially exempt transfer (PET).
As the PET took place four years ago, there remains three years until the assets are excluded from their estate, although they may already benefit from taper relief.
However, they have issues with some buy-to-let investments they maintained and want to be sure this will not affect their inheritance tax planning.
There have been some difficult tenants in the flats and they find the hassle increasingly stressful.
They have already sold one property and have another on the market. They want to keep a third property that is located nearby and has a long-term tenant who is a family friend.
By selling the two properties Paul and Elaine will generate an extra £600,000 of capital after tax and expenses, and want to place some of this in a trust for their grandchildren.
To do this they are interested in using a relevant property trust (RPT), with guidance for the trustees to manage the property to produce long-term income for their grandchildren.
Placing the proceeds from the sale of the buy-to-let in a RPT would be treated as a chargeable lifetime transfer (CLT).
This would mean during their lifetime, if Elaine and Paul made a PET first and then a subsequent gift into a CLT, the value of the CLT would be looked at against the nil-rate tax band to ascertain if an immediate entry charge would apply. For example, if the gift to the RPT is £600,000 this is tested against Elaine and Paul’s individual nil-rate band (i.e. £325,000 x 2). Therefore, no immediate tax charge would apply.
If Elaine and Paul made a PET followed by a CLT, and the PET was made within seven years of their death, the PET would fail and be looked at as a CLT. This failed PET would be added to the later CLT to see if this breaches the nil rate-band. If the nil rate-band is breached any excess will be subject to inheritance tax at 40% (or at 20% if there has been an entry charge on that portion).
For example, if a PET of £400,000 is made in the first year, a CLT of £600,000 in the fourth year and death occurred in the sixth year, the CLT and failed PET would equal £1 million. This is £350,000 more than Elaine and Paul’s combined nil-rate band (assuming the nil-rate band at the point of death is £325,000 x 2) and so there will be 40% tax to pay on the excess. Tapering may apply if the gift was made more than two years previous.
The 10-year periodic charge applicable to discretionary trusts will take into consideration any chargeable transfers made at the creation date of the trust and the seven years prior to the creation date. Here any failed PET will also be seen as a CLT.
This article was previously featured in New Model Adviser