Inheritance Tax (IHT) planning is often overlooked in favour of more immediate investment planning concerns for retirement. However, increasingly IHT is an issue that more and more individuals and families are forced to address.
Currently, the government provides a ‘nil rate band’ of £325,000 (frozen until 2018), upon which IHT is exempt. Married couples can use two nil rate bands on second death meaning that estates valued at less than £650,000 will pay no tax.
Although the government allows annual IHT exemptions, such as the ability to gift up to £3,000 per year or regular gifts out of income, it will not provide substantial IHT savings unless conducted over a long time frame. Of course, larger gifts, either directly or via Trusts, can be made but these rely on the donor living for the next seven years, in order that the gift be deemed ‘outside’ the estate. With increasing life expectancy and advances in medical science people typically underestimate their longevity. Are gifts a good idea when you are unsure that your capital assets will last your lifetime or if Long Term Care provision is likely?
Establishing a life assurance policy, written in Trust, is an alternative option with the sum assured used to cover the IHT due. However, this involves an additional monthly cost to pay for the cover. For the elderly or those in poor health, life assurance simply may not be an option.
So are there alternatives to these traditional IHT planning methods? One option that people are unlikely to be familiar with are investments that benefit from Business Property Relief (BPR). BPR legislation is nothing new, having been introduced in 1976 by the UK government offering tax incentives for investors and to stimulate new private enterprise in businesses that meet certain criteria. In order to qualify a business must be unquoted, actively trading and cannot be an investment company. Investors in businesses that secure this relief are 100% exempt from IHT after only 2 years.
The current rules allow a wide range of BPR qualifying investments to UK investors. This includes anything from forestry, renewable energy (solar/hydro power etc), property finance to asset backed businesses such as pubs, health clubs, hotels. Stocks listed on the Alternative Investment market (AIM) also typically qualify for BPR relief.
At first glance BPR investments appear to offer significant IHT planning advantages. Exemption from IHT after only 2 years is considerably faster compared to the traditional gift or Trust route. This may be particularly attractive to elderly clients where they believe they may not out live the 7 year gift rules.
BPR investment schemes can sometimes offer ongoing investor control with access to capital, should an individual’s circumstances change, for example if money is needed to pay for care fees. This flexibility, when available, compares favourably to direct gifts or Trusts, where the settlor typically no longer derives any further benefit.
BPR investments do not require any complex legal/Trust structures and investors are not subject to any medical underwriting. This may provide a feasible IHT planning opportunity to those in less than perfect health and a relatively simple solution to establish without input from solicitors or other family members.
Whilst these benefits are extremely attractive, it is also worth reminding ourselves of the risks associated with BPR investments. Firstly, by the very nature of investing in unquoted businesses there is a considerable degree of investment risk. The potential for losses with AIM stocks for example is significantly greater compared to FTSE 100 companies. However, there are funds that exist which invest in a portfolio of AIM shares and this diversification may help to mitigate investment risk. Valuations also may be difficult to ascertain. Any investment losses incurred may negate or even outweigh any potential IHT saving achieved.
Liquidity in BPR qualifying investments may also be limited which could restrict access to capital at times when it is required. As such, these schemes will not be suitable for everyone. In order to achieve the IHT saving it will be necessary to hold BPR investments until death. Selling a BPR qualifying investment, even after 2 years, will put the proceeds back into the individual’s taxable estate.
Ongoing policy/legislation risks associated with BPR are also relevant as IHT becomes ever more a political issue. Tax legislation is often subject to change and the existing tax incentives being offered via BPR investments may change in the future with potentially less favourable tax relief. The definition of what investments meet the BPR criteria may also potentially be restricted. What may be a BPR qualifying investment at the present time may not be in the future.
It is important to seek professional planning advice to mitigate the impact of IHT as it becomes an increasingly complicated financial planning issue. Such advice is crucial when considering a BPR investment, given the specialist nature of these arrangements..