• Aged 74
• In good health
• A widower
• A basic rate taxpayer
• Inherited fully the estate of his late wife, Joyce
• Has two children, three grandchildren and one great-grandchild
• His assets total £1.5 million
• Still lives in the family home, worth £500,000
Barry has always been diligent with the family finances and was careful to ensure his family wanted for nothing.
He and Joyce brought up two sons and had an extended family by the time of her untimely death last year.
He never thought of himself as especially wealthy but wanted his sons to receive all that he had accumulated when he died.
As he always slightly resented the amount of tax he paid each year, he made sure that he and Joyce paid the maximum they could into their cash ISAs every year.
And he was interested to learn that when Joyce died, he could transfer her built-up ISA fund into his account with full income tax relief on the cumulative sum. This meant that his cash ISA now amounted to £150,000.
The interest rate was pretty rotten of course and sometimes it beat inflation and sometimes it didn’t.
There was also something else that he had read about, which was concerning him.
The Sunday paper had an article about inheritance tax in it and it made the comment that, although ISAs were excellent and tax-free, ‘they weren’t usually exempt from inheritance tax of course’ – unless they were invested in Alternative Investment Market (AIM) shares.
It went on to say in some circumstances, the inheritance tax bill relating to an ISA could be more than the whole of the tax-free income and gains it had accrued!
This concerned him so he went to see his financial adviser to ask more.
His financial adviser told him:
- There is an inheritance tax ‘nil rate band’ and everything above that is taxed at 40%
- There is also a ‘residence nil rate band’
- The unused nil rate bands can be transferred from Joyce’s estate
- His potential inheritance tax (IHT) bill is £260,000
The potential IHT liability is: (£1,500,000 - £850,000) x 40% = £260,000.
As you would expect, Barry had some questions for the adviser, who answered them.:
‘I thought a new allowance applied from 6 April 2017, which will save me IHT?’
- ‘‘Yes, there is a new residence nil rate band (RNRB) that applies if you own a home. The figure I gave you took that into account and the RNRB reduced the tax bill by £80,000. And it will increase by another £75,000 by the time you’re 77 (saving another £60,000 IHT).’
‘What are AIM shares?’
- ‘They are shares in small companies and can be volatile high-risk investments – but they are subject to 100% relief from IHT after you have owned them for two years.’
‘Can I do anything else with my ISA, less risky than AIM shares, to save IHT?’
- You could cash in your ISA and put the proceeds in trust, which could save you £60,000 IHT after a qualifying period of seven years.’
His adviser explained that if he did cash in his ISA, and invest the proceeds in a Wealth Preservation Account for example, it would not be tax-free when eventually cashed in. It was, therefore, a matter for him to balance the tax-free status of the ISA but IHT applying at 40%, with an investment in trust which was subject to income tax on the investment gain but free of IHT – as long as he lived for a further seven years.
If Barry did invest in a Wealth Preservation Account, this achieves his objectives because:
• Provided he lives for another seven years, the initial gift will not be part of Barry’s estate on death
• His children, grandchildren and greatgrandchild can receive trust funds either before or after his death, at the discretion of the trustees
• The trustees will decide on the appropriate amounts and timing; guided by a letter of wishes that Barry can provide
• Any investment growth will accrue outside Barry’s estate, from day one, so will not be subject to IHT when he dies
In addition, the Wealth Preservation Account allows the trustees to sanction payments to Barry each year if he is in need of money, although he may pay income tax on any investment gain.
Also, Barry’s trustees can help out his grandchildren if they need help with buying their first home, for example, by passing on trust funds to them.
For more information on the Wealth Preservation Accounts, please contact your professional adviser.
Please note: The events and all characters described in this document are entirely fictitious, but the calculations and tax situation described are accurate and feasible. The information regarding taxation is based on our understanding of current legislation, as at March 2017, which may be altered and depends on the individual circumstances.