Why the Top 3 ingredients for Inheritance Tax could spell dISAster for many savers
"The happiest mourner at a rich man’s funeral is usually Uncle Sam". Richard Miller
While Richard Miller was talking about America, UK estates will increasingly find themselves subject to Inheritance Tax (IHT). Once only an issue for the very rich an increasing proportion of wealthy Britons will be caught, with IHT predicted to hit 1 in 10 deaths by 2018. IHT receipts amounted to £4.7bn in 2015/16, an increase of 22% on the previous year, accelerating from the 12% year on year growth observed in the five previous tax years.
Despite recent government measures to curb such rapid IHT growth, the Office for Budget Responsibility (OBR) recently increased its forecasts, estimating a total IHT collection of £6.2bn by the tax year 2020/21, showing a significant increase on the forecast £5bn collection for this tax year (2017/18).
What is IHT and how is it calculated?
IHT is charged at 40% of the total taxable estate over a threshold of £325,000 per individual. This nil rate band has been frozen since April 2010; though married couples and those in civil partnerships can combine their nil rate bands to pass on £650,000 to their heirs.
In addition to this, since April 2017 the Family Home Allowance has increased the potential to threshold for IHT. The ‘Residence Nil Rate Band’ (RNRB) takes precedence over the ‘nil rate band’ and provides an additional level of shelter. However, its practical impact remains questionable with it applying to only direct or lineal descendants and their spouses and civil partners.
For the 2017/18 tax year RNRB adds £100k to the existing £325k NRB per individual, increasing by £25k each year to £175k by 2020/21. Thereafter – RNRB will increase by inflation, (as measured by CPI). Estates over £2m will see the allowance tapered by £1 for every £2 the value of the estate exceeds £2m. For example: RNRB will be lost for an individual with an estate worth £2.2m in 2017/18, increasing to £2.25m in 2018/19 to £2.35m in 2020/21.
Why are so many more families becoming affected by IHT and what are the key contributors to tax paying estates?
Against a frozen nil rate band – the key factor driving many more families into potential IHT liability is rising asset values.
According to HMRC’s latest Inheritance Tax Statistics; Properties, Securities and Household Savings make up the ‘top 3 ingredients’ of taxpaying estates.
Each year residential property makes up nearly one third of the total value of taxpaying estates. With average national house prices rising at 6.5% per annum, many homeowners will breach their nil rate band simply through the value of their primary residence.
Cash savings and securities are the next two largest proportions. In the last five years the FTSE 100 including dividends has increased by over 48% (as of 14th September 2017). Those with investments in overseas market such as the United States or in smaller companies may potentially have seen even larger gains. Low interest rates have increasingly seen investors shift to either equities or property in the pursuit of higher returns, potentially increasing the value of the taxable estate.
Are ISA investments included in these contributors?
While ISAs are extremely tax efficient vehicles during a holder’s lifetime, allowing investors to accumulate gains free of capital gains and income tax, on death they fall within the taxable estate and will be subject to IHT if the estate exceeds the nil rate band.
According to the latest ISA statistics, recently released by HMRC the total value of Adult ISA holdings stood at £518bn, an increase of 7% on the year before. With an average of 48% of this sitting in stocks and shares ISAs (the other 52% in Cash ISAs) it is not difficult to see how many normal working people in their 50s and beyond will find themselves with potential (and mounting) IHT liabilities.
What can be done?
Solutions do exist, and advisers are regularly helping their clients mitigate significant parts of their potential IHT liability. This does not require complex structures, nor does it leave the client without access to the money. This estate planning utilises Business Relief, which was introduced over 40 years ago, in 1976, to promote investment into growing UK businesses.
UK private companies including many stocks listed on the Alternative Investment Market (AIM) qualify for Business Relief. These investments must be held for a minimum of two years and at the point of death. Assuming the investments meet the criteria for Business Relief including the required holding period then these assets are deemed to be outside of the taxable estate. This is a potential tax saving of 40% for the inheritors on that portion of the estate.
Since 2013, AIM stocks have been eligible to be held in ISAs allowing investors to benefit from the IHT benefits of Business Relief while maintaining the traditional tax benefits of the ISA wrapper. Advisers can start clients on the path to mitigating IHT, by allocating this year’s ISA allowance of £20,000 to an AIM IHT Service.
ISA IHT solutions: Business Relief
Puma’s AIM IHT Portfolio Service seeks to offer investors the potential growth benefits of a carefully selected portfolio of AIM stocks combined with the benefits of IHT mitigation. Investors can choose to hold it either in an ISA wrapper or outside or a combination of the two.
The Service can be accessed directly, as well as via leading Adviser wrap platforms: Ascentric, Standard Life and Transact, allowing advisers to retain the benefit of keeping clients on platform. In fact, the platform makes it possible to hold multiple discretionary fund manager propositions in the same tax wrapper, providing excellent ground for a ‘core’ and ‘satellite’ approach to risk-targeted investing with a specialist estate planning and growth solution provided by Puma.
Winner of the Growth Investor Award 2016 for Best AIM Investment Manager, Puma AIM has delivered strong growth for investors since its launch in 2014; outperforming the AIM All Share Index by over 44% in the same period. An investment of £100,000 in Puma AIM at launch would be worth at the end of June 2017 £167,360. Providing the investment was held for a minimum of two years and at the time of death, the portion of the portfolio invested in AIM stocks would be potentially outside the estate for IHT purposes.
Justin Waine, Investment Director