The WAY Group Newsletter for Financial Advisers | November 2009

Recession Tests The Flexibility Of IHT Planning

(Picture left: Mark Benson TEP CertPFS, WAY Technical Manager)

In an unpredictable world there is always too much to worry about. Mark Benson TEP CertPFS, WAY Technical Manager, examines the importance of IHT planning in the current economic and political climate ...

"Let our advance worrying become advance thinking and planning" - Sir Winston Churchill (1874 -1965)

In an unpredictable world there is always too much to worry about. One very legitimate and topical worry since the middle of the current decade has been the lengthening shadow of Inheritance Tax (IHT) falling upon the estates of the moderately wealthy as well as those of high net worth. However, in a period where the worries and hard effects of recession are felt more keenly, the adaptability of our financial plans is tested to the limit. In this article I look at how the flexible IHT mitigation trust is able to meet the changing needs of all generations of the family. Indeed we shall see how such plans can be a useful tool in both coping with the negative impact of recession and exploiting the opportunities that arise from lower asset prices.

The wider cast of the IHT net has arisen due to a combination of the super-inflation rates of house price growth and a deliberate fiscal drag that has left growth in the IHT nil rate band lagging behind that of a typical family home. The situation is compounded for the many people who prudently build up a nest egg over the course of their lifetime in order to benefit from a cushion against the vagaries that may come in their later years. Fortunately in most cases the worst will not come to pass and the nest egg will ultimately pass down to children and grandchildren.

Many of these families have worked with their IFA to put in place IHT mitigation plans. Such plans typically utilise a trust wrapper within which a reversionary interest is carved out in favour of the settlor of the trust. The trust assets are then invested in either unit trusts or investment bonds, as appropriate to the tax profiles of the settlor and beneficiaries. Thus two causes of worry are calmed by protecting the nest egg from the unnecessary and unwelcome tax charge, whilst retaining the ability to benefit from the wealth in the future. The IHT saving is principally achieved by making the gift early enough to survive the seven year inter-vivos period, after which the gift will generally fall out of the individual's estate.

Some individuals will need to derive a regular income from the assets from the outset, and consequently can benefit from a discounted structure that fixes a regular reversion of cash, units or policies and generates an immediate reduction in the potential IHT bill. However in the majority of cases the individual will hope not to dip into the nest egg, but will want the peace of mind that a trust can offer compared with an outright lifetime gift to the next generation(s). In these circumstances flexible trust structures are preferred because, although they do not offer a discount during the seven years, they are highly adaptable to the family's changing circumstances.

The principal benefit of the flexibility is to grant the trustees the power to defer scheduled reversions and thus retain assets within the trust and outside of the settlor's estate, in years when there is no requirement for additional funds for the settlor. Each year the reversion can be tailored to the contemporary needs and does not have to be anticipated and fixed at the outset. Over each of the last four years at WAY* approximately 7 in 8 annual reversions have been deferred in full by the independent trustees, with only 1 in 8 granting a reversion to the settlor.

It will be very interesting to see if the rate of reversions increases as the recession bites harder on personal finances in the months to come. We suspect that the rate may not in fact change dramatically. This is on the basis that we have thus far only seen a slight increase in the rate despite the fact that the credit crunch has been felt for many months already. The majority of IHT mitigation plans are set up by individuals who have already retired and who are more likely to enjoy a secure pension income that is relatively unaffected by the recession. In fact we believe that the recession is likely to bite much harder on the beneficiary generations who will tend to be of working age and very likely in the process of paying down mortgages and raising children.

The charity Credit Action* has recently compiled a number of statistics on the effect of the recession in Britain. These include the estimate that 1 in 33 people in work will become unemployed in 2009; 1 person is declared bankrupt or insolvent every 4.35 minutes (which translates to just over 120,000 over the course of a year); and 1 house will be repossessed every 10 minutes (52,560 over the year). It would be perfectly reasonable, and definitely healthier to focus on the positive side of these statistics - i.e. that the vast majority of people will keep their jobs, their homes and stay solvent. However it is certain that substantially more that 1 in 33 working people will be worrying about their job security this year.

The challenges of recession highlight another powerful feature of the flexible IHT trust, namely that the trustees also have the power to assist the beneficiaries during the lifetime of the settlor. This facility is not offered by discounted plans where the capital is locked within the trust, since it must drive the regular reversions delivered to the settlor. The trustees of the flexible trust are able to assist a beneficiary who, for example, needs further capital to support their business. Many small and medium sized enterprises are finding themselves in this position in the absence of an offer of financing from their hard up bankers. Given the inherent risk of an outright capital injection, assistance could be provided by way of a loan (possibly secured on assets) thus directly replacing the missing bank financing.

The power to appoint capital may also be of benefit in more positive circumstances, to provide assistance to a beneficiary to purchase a home and take advantage of the recent recovery of house prices to less outrageous levels. Indeed by providing assistance now rather than having to wait until after the death of the settlor, that settlor may be able watch their children benefit from the next property boom which seems already to be underway!

With the worries of the recession to the fore other worries inevitably recede, including the level of concern over IHT. This change of mood has come about as asset values have fallen back, and particularly since the Conservatives proposed an increase in the nil rate band to £1m. So should investors still worry about IHT? As financial planners and with a respectful nod to Mr Churchill we can confidently say: No, investors should not worry, but they should still plan. Property prices have fallen but they are still at a similar level to mid 2004* when IHT was worrying many families. We can also very reasonably question the Conservatives' commitment to increasing the nil rate band should they gain power, at least in the early stage of a new parliament. It is widely acknowledged that the nation's finances are in a terrible state and that tax cuts may inevitably remain as aspirations for a number of years yet.

However the most potent reason not to ignore the need for IHT planning is that any delay wastes the opportunity to start the 7 year clock ticking and to make good progress in moving assets out of the estate. It is an unavoidable fact that we are getting older day by day, whereas future asset values and changes to tax policy are not at all certain. The flexible trust can again help here because reversions can be set at a pattern that could allow assets to return to the settlor very quickly should a change in the IHT regime negate the need for the tax planning. Nor should it be overlooked that an IHT trust is not a "black hole" for assets. The trust is specified by the settlor to meet their objectives for the long-term transfer of assets to their chosen beneficiaries.

In conclusion IHT mitigation should still form a key part of planning for every family's finances, and advisers who have put in place sufficiently flexible arrangements will be able to fine tune the plans to meet future needs and challenges. The flexible IHT mitigation trust is able to take a full roll in the adaptable planning called for in difficult economic times, by providing access to family wealth across the generations to provide help where needed and grasp the opportunities to benefit from future recovery.

* Data sources:
Reversion rates: Sample of 581 WAY Flexible Inheritor Plans compiled by WAY Investment Services Limited (Compiled: 1st November 2009).
Recession statistics: Credit Action Debt Facts and Figures. (Compiled: 1st August 2009).
House prices: Halifax House Price Index - July 2009

Yours sincerely,

Mark Benson TEP CertPFS,
Technical Manager, WAY Investment Services Limited
6th November 2009.

Ends-

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How to contact us

We hope you found this IFA e-newsletter interesting and informative and that some of the issues raised will prove useful for developing business with your clients? If you wish to discuss any matters arising from this newsletter or, indeed, want to talk to us about any of WAY's products, then you are most welcome to call either Tony Lyons, IFA Support Manager, or Mark Benson TEP CertPFS, Technical Manager , on head office telephone number: 01202 890895. Or, if you prefer, you can use the website: Contact Form to get in touch. We look forward to hearing from you.

Newsletter: November 2009.

Please Note: This newsletter commentary has been prepared for Financial Intermediary Clients and Professional Associates of WAY Investment Services Ltd and is not intended for and must not be distributed to Private Investors. This information is supplied to you in confidence and you may not pass it on to any other party without prior written consent. Past performance is not necessarily a guide to future returns and changes in rates of exchange between currencies may cause the value of investments to rise or fall. No representation or warranty is given (express or implied) as to the accuracy, completeness or correctness of the information nor the opinions, interpretations and conclusions contained in this commentary. The commentary does not constitute investment advice or a recommendation to purchase or sell any security. Neither the author nor WAY Investment Services Ltd accept any liability whatsoever for any loss or damage arising in any way from any use of or reliance placed on the commentary. WAY Investment Services Ltd is an Appointed Representative of WAY Fund Managers Ltd which is authorised and regulated by the Financial Services Authority.