Casebook Brief
William had retired from his role as CEO of a large international group of companies at 65. He was in receipt of an index-linked pension of c£300,000 per annum from his previous employer’s defined benefit pension scheme, as well as salaries and dividends from a small number of companies that he sat on the board of as a non-executive director (NED). The total household income was approximately £500,000 per annum (gross).
Throughout William’s career, he had used bonuses and spare income to pay off their mortgage, fund a very comfortable lifestyle (including two family holiday homes) and support their children and grandchildren. William and Mary were in their early 70s when they first approached me for advice, which was triggered by the fact that one of the businesses that William was a NED for, had been sold and he had received c£10m for the sale of his shareholding.
This is a real life case study. Names and some other details have been changed to protect confidentiality. Stock image used. Reproduced by kind permission of Financial Planning Today.
During the initial meeting with William and Mary, we identified and agreed a number of priorities, which were:
They were very keen to make substantial gifts to family members.
They had always been very benevolent and wanted to support local charities.
They wanted to replace the income that William had lost now that the shares had been sold, which was c£200,000 per annum (gross).
They recognised that there would be a significant inheritance tax liability, so they wanted to plan their affairs to help mitigate the liability.
William remained a NED of other companies and there was the possibility of other opportunities, which meant that he had to maintain access to significant capital, but not necessarily all at short notice.
William was paying significant amounts of income tax and wanted to address that.
First steps
The very first piece of advice was to protect as much of the cash as possible by recommending they transferred the maximum of £4m into a NS&I Direct Saver Account – although it did not provide the best interest rate, it meant that at least £4m was 100% guaranteed by the UK Government and they
did not need to worry about the Financial Services Compensation Scheme (FSCS) limit of £85,000, at least on the first £4m.
The second piece of advice was to delay making gifts until we had the opportunity to co-produce a financial plan with cashflow forecasting and a detailed inheritance tax computation; and have the opportunity of setting out our generic recommendations. As there was significant scale and complexity associated with their circumstances, there were two very important early considerations
In the advice process:
Firstly, many of the advice points that we were likely to be presenting to the client would have a tax consequence. We therefore recommended that we worked collaboratively with William and Mary’s existing tax adviser from outset.
Secondly, it was difficult to accurately assess the amount of time that would be required to prepare their financial plan and then to implement any recommendations.
Consequently, we agreed with the client that we would proceed on a time-cost basis and invoice at each key stage rather than attempt to calculate a fixed fee or apply an arbitrary percentage of an amount ultimately invested.
What advice did we provide?
These are the key components of the implementation work that we undertook based on the clients’ agreed financial plan:
The establishment of two discounted gift trusts – the first as a discretionary trust and the second as an absolute (bare) trust to ensure that a chargeable lifetime transfer (CLT) occurs before any potential exempt transfers (PETs) to preserve the nil rate band on the discretionary trust. This provided an immediate reduction in the taxable value of their estate and the regular withdrawals also replaced most of the net income that William had lost by virtue of the sale of his shares and stepping down as a director of the company.
The cashflow forecast demonstrated that, even in circumstances where both required expensive nursing care in later life without having to sell their family homes, they could safely gift £5m. William and Mary were hugely gratified to be able to make substantial gifts to family members, one of whom was terminally ill and was soon after able to die in peace knowing that his mortgage had been cleared and his widow was left financially secure, which would not have been the case without the gift from William and Mary.
We advised that a significant cash reserve be held in their NS&I Direct Saver Account and the maximum amount in Premium Bonds – they were more concerned about breaching the FSCS compensation limits than they were about maximising interest rates. They also wanted immediate access and confidentiality.
We established a general investment account (GIA) for each of them to provide the balance of the income they needed to replace William’s lost income and to provide the prospect of capital growth but with access to capital if required in the longer term. The fund selection and ownership was structured to optimise the use of allowances and the GIAs also drip fed their ISAs.
A number of lump sum gifts were made to registered charities. We calculated the optimum level of charitable gifting in the current tax year to significantly reduce William’s income tax liability through the use of Gift Aid.
We calculated the level of spare income that could be used for gifts from normal expenditure to then set up regular gifts to fund school fees for grandchildren without invoking lifetime charges on the gifts. Consideration was also given to a number of other options that were, for a variety of reasons, either discounted or proved not viable. These included Business Relief (BR) investments, establishment of a charitable trust and a Family Investment Company (FIC).
Technical issues that are sometimes missed
A gift to a discretionary trust is a CLT and subject to a lifetime inheritance charge of 20% to the extent that it exceeds the available nil rate band.
A gift to an individual or a bare (absolute) trust is a PET and does not trigger a lifetime charge but is added back into the value of the estate if the donor dies within 7 years of from the date of gift. CLTs drop out of charge after seven years as long as PETs are not created after the CLT. If a settlor creates a mixture of PETs and CLTs this can lead to a ‘14 year shadow.’ If a PET fails and becomes chargeable it pulls into charge any CLTs made within 7 years of the failed PET thus potentially going back 14 years.
The other effect can be that the discretionary trust does not have a nil rate band to help reduce the 10 year periodic charge and any exit charge. It is therefore very important to consider the order of gifting where a relevant property (discretionary) trust is being recommended.
The other thing to be careful of is where grandparents are paying school fees directly to the school by way of regular gifts and the gifts are not covered by an exemption. In order for any gift to be deemed a PET, the gift must result in an increase in the value of the estate of the recipient. If it does not, the gifts are CLTs and immediately chargeable to IHT.
So, where the grandparent has paid school fees directly to the school (bypassing the grandchild’s account) and has fully utilised their nil rate band (NRB) on a gift to, for example, a discretionary trust, the ongoing gifts of school fees (assuming exemption is not available) are CLTs and trigger a 20% lifetime charge on each payment or, if the NRB is available, the CLTs will erode the NRB that could otherwise be available on death.
What Happened Next...
As with most high net worth clients, there is invariably a degree of complexity. Also, it is rarely possible to meet all of a client’s aspirations from outset. So, the provision of an ongoing composite Financial Planning and investment review service provides significant value to the clients and their family. There is also value in working collaboratively with the clients’ other professional advisers as part of the ongoing service.
One significant example with this particular client is that William happened to own shares in an AIM listed company that, as a result of Covid, have reduced in value from c£500,000 to c£20,000. This created an opportunity to transfer ownership of the shares to his ISA to crystallise a loss that can be offset against gains that were to be crystallised in his GIA, thereby reducing the CGT to £Nil.
Also, in the event that the AIM shares grow back to their previously high level, the gains will occur within his ISA wrapper and avoid CGT on eventual sale.