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Tolley's Practical Tax by Sarah Deeks LLB FCA

An area of increasing relevance to every practitioner, examined by Sarah DeeksLiving to 80, 90 or beyond is now common but with the advancing years come challenges. Declining physical health may lead to major lifestyle changes such as moving into sheltered accommodation or a care home. Paying for this care is far from straightforward and will require the elderly person to make and understand complex financial transactions and their tax implications at a time when they are having to adjust to their new environment and increasing frailty. The falling birth rate, increasing numbers of single person households and the dispersal of families only add to the difficulties faced by infirm elderly people. Professional advisers often find themselves helping long-standing clients through this difficult period.

There are three main issues for an elderly person moving into a care home to address:
• choosing suitable accommodation;
• paying the fees;
• deciding what happens to the family home.

Choosing suitable accommodation

There are two main types of care home, personal (residential) and nursing (for residents with a higher level of dependency). An elderly person may enter a care home temporarily (to give a carer a break) or permanently. In the latter case the social services/work department of the local authority should be involved. Moving independently could result in higher costs, and the move may not even be necessary if additional support can be made available to allow the elderly person to remain in their home. A social worker will carry out a community care assessment (NHS and Community Care Act 1990, s47) to ascertain the elderly person’s needs. If they conclude that these can only be met in a care home, a suitable home can be selected.

Paying the fees

Elderly people with savings of less than £12,250 (£13,500 in Wales; £11,750 in Scotland), including the value of their home, are entitled to have their care home place funded by their local authority. Those with savings of more than £20,000 (£20,500 in Wales; £19,000 in Scotland) usually do not receive any financial assistance. Pensioners with savings between these limits receive some help. Elderly people requiring hospital style care and those detained under the Mental Health Act 1983 are funded by the NHS/health board.

Although savings include the value of the elderly person’s home, its value can be disregarded:

• for the first 12 weeks after permanently moving to a care home - to allow time to see if the arrangements work;

• if the care is temporary for up to 52 weeks (subject to local authority discretion);

• if it is occupied by a spouse or partner (but the spouse may have to make a financial contribution to their husband or wife’s care);

• if a relative aged over 60 lives there, or if a person under 60 who is incapacitated occupies the home;

• if it is the permanent home of another person such as a carer (usually an adult son or daughter) but only at the discretion of the local authority. Coownership may, however, significantly reduce the value of the property to be taken into account.

Paying own fees

Those paying their own fees without local authority assistance have two options as to how they proceed. They may contract with the care home themselves and then when their resources have dwindled to the relevant threshold ask the local authority for help. Alternatively, social services can contract with the home, the resident reimbursing them until their resources have reached the monetary limit. The second option has two advantages; price (the council may be in a stronger negotiating position) and flexibility at the time when the elderly person’s resources are approaching the financial threshold (assessments may take several months).

Care by a registered nurse in a nursing care home is free, regardless of the person’s resources (in Scotland assessed personal care is also free). A set weekly amount to cover nursing costs is paid directly to the care home which should be passed on to the resident as reduced charges. In England, payment is assessed in three bands according to need.
An elderly person’s requirements should be regularly reviewed as they may change rapidly.

Care home fees may be funded by pensions, savings, and funds raised against the family home, or from its sale. The elderly person may be entitled to benefits such as attendance allowance (currently £39.35 per week, £58.80 for those requiring more care), which is not means tested or taxable. Care insurance can be taken out to finance the cost so that the home does not need to be sold. It can be expensive (depending on age and health at commencement). Premiums do not attract tax relief but payments made for care are not taxable.

Local authority funding

Elderly people entitled to local authority care funding contribute their state, occupational and personal pensions less a sum to cover their personal expenses (currently £18.10 per week; £18.40 in Wales). The local authority ensures that they claim all relevant state benefits such as income support and pension credits and then they make up the shortfall.

The amount that the local authority are prepared to pay for the person’s assessed needs may not cover the cost of their preferred care home. After the initial 12-week disregard self top-ups are not permitted because this depletes the pensioner’s resources too quickly. If there is a shortfall the difference must be paid by a third party (a relative or benevolent fund). Gifts of capital to maintain a dependent relative are exempt from inheritance tax (IHTA 1984 s11) and there are no income tax consequences.

Example 1

Mr Black has a weekly pension income of £140 and minimal savings. His care home fees are £450 a week but the local authority will only pay for a place costing £400 a week because his needs can be met in a home charging this level of fees. His daughter agrees to make up the £50 per week shortfall so that her father can go to the home he prefers. Mr Black will keep £18.10 a week for his personal expenses. The rest of his pension £121.90 per week is paid for his care. His daughter pays £50 per week and the local authority pays the balance of £278.10.

The family home

The family home is considered to be savings and taken into account when assessing an elderly person’s contribution to their care home fees (subject to the exceptions above). Keeping hold of the family home is the single biggest issue when discussing financial and tax matters with elderly clients as its loss can be traumatic for the whole family.

Giving it away

There are three main reasons for trying to give away the family home – to save care home fees, protect the home of an adult child and to mitigate inheritance tax, but doing so is fraught with difficulty. Whether giving away the home is a viable option depends on the family relationships as well as the wishes of the elderly person.

It is a popular myth that the family home will not be taken into account by the local authority if it has been given away. The seven-year rule for potentially exempt inheritance tax transfers is often confused with an amnesty for care home fees. To be successful, any gift of the family home must be made well before the elderly person needs care and there must be no evidence that long-term care planning was ever discussed. The local authority can recover funds from those to whom the home was given if the donor has deliberately deprived themselves of assets by making a gift within six months of the need for care arising. If the home (or other assets) was given away more than six months before the care need arose the elderly person may be deemed to have notional capital based on the value of the gift. There appears to be no time limit for the operation of this provision if the home was given away to decrease the amount that the elderly person would have to pay for their care.

Example 2

Mavis (80) is independent, in good health with an estate worth £200,000 so inheritance tax planning is not an issue. Her advisers recommend that to avoid her home being used to pay for care home fees in the future she should gift it to an interest in possession trust. Mavis retains an interest in the property for her life, and on her death the remainder will pass to her granddaughter. The disposal into trust is covered by the principal private residence exemption. Three years later Mavis is admitted to a care home. The local authority successfully claims that as the gift was made specifically to decrease the amount she would have to pay for her care, she is deemed to still have the capital (Yule v South Lanarkshire Council, The Times 18 May 1998).

Example 3

Nora (81) lives independently because her daughter Mary provides her with considerable day to day help. She is unaware when she gives Mary the bulk of her estate that she could require alternative accommodation in the future which she might have to pay for. She enters a care home two years later. If Nora does not have the relevant intent to deprive herself of assets to obtain funding for a care home, a claim by the local authority that she has deprived herself of capital may not succeed (Beeson v Dorset County Council [2001] EWHC Admin 986).

The concept of deprivation of assets does not just apply to gifts of the home, it could also be extended to monetary gifts (including those exempt from inheritance tax), potentially exempt transfers and gifts of assets into trust if the motivation test can be proven.

If paying care home fees is not an issue, giving the family home to a child or other relative is a potentially exempt transfer and will be effective for inheritance tax purposes if the donor survives for seven years. Tapering relief applies to deaths between three and seven years. If a married couple own their home as tenants in common rather than joint tenants, upon the death of the first spouse their share of the domestic home could be left to the children (or a discretionary trust), thereby using up their nil rate band. The other spouse would have undisputed rights to live in the home for life. Potential problems include children divorcing and the necessity for the co-owner(s) to pay their share of the upkeep of the property. The gift of a house to an adult child subject to the condition that an elderly parent can continue to live in or have access to the property for life is ineffective for inheritance tax purposes as a gift with reservation of benefit. Some gifts may be caught by the pre-owned asset rule from 6 April 2005 (FA 2004 s84).

Deferred Payments Scheme

Some local authorities allow an elderly person entering a care home to defer payment until after their death if the only way the fees could be paid is by selling their home. Councils are not obliged to offer the scheme but failure to do so can be challenged. The scheme could be used in conjunction with renting out the home.

Rental income

All or part of an unoccupied family home could be rented out to produce additional income to pay the care home fees. It would also appear that a mortgage could be taken out with the interest being deductible against the Schedule A rental income (Business Income Manual 45700). Provided that the gain attributable to the let period does not exceed the lower of £40,000 or the exempt gain, the letting will not have any capital gains tax consequences.

Equity release

The family home can be used to generate income under an equity release scheme such as a mortgage roll-up, home income plan or home reversion plan. These are sometimes called ‘care plans.’ Good financial and legal advice is essential.

Annuities generated in this way are not usually the preferred option but they may provide useful income to pay for care or medical treatment particularly where there are no close relatives to inherit the estate. Pitfalls include:

• the annuity may increase the taxpayer’s income to the level where age related personal allowances are clawed-back and marginal tax rates are high (but so could income generated by selling the home);

• the loss of means-tested state benefits; and

• the risk to the home if the terms of the policy are not complied with or if interest rates rise.

Mortgage roll-up schemes usually allow 20-50% (depending on the taxpayer’s age) of the value of the property to be borrowed by way of a mortgage. The interest (preferably fixed) is rolled-up and repaid along with the capital when the borrower dies. Schemes should include a guarantee that the total of the rolled-up interest and mortgage will not exceed the value of the property at death. There is no tax relief on the interest. No tax is charged on the lump sum received but income generated by it is taxable in the usual way.

Home income plans usually raise a secured loan (preferably fixed interest) of up to 70% of the value of the home which is used to purchase a life annuity at a rate dependent on the annuitant’s age and sex. If they are in poor health an impaired life annuity may be appropriate. Couples must ensure that the scheme allows the right to live in the home and pays income until the second death. New schemes receive no favourable tax treatment but plans taken out before 9 March 1999 are still eligible for MIRAS relief at 23% on the first £30,000 of the loan.

Home reversion schemes generate a lump sum or annuity in exchange for the elderly person selling all or part of their home to a financial institution at a discount on the normal market value with the right to occupy it for life. If the taxpayer sells the home before they die, the reversion company gets its money back sooner than anticipated but the taxpayer’s income will remain unchanged. The capital sum generated is tax-free but the income from the invested capital will be taxed in the usual way. Some schemes may technically fall foul of the preowned asset rule, but in response to a parliamentary question, the Paymaster General has given an assurance that the pre-owned assets rules will not be applied to bona fide equity release schemes.

Council tax

Where an elderly person lives in a care home, is in hospital or being looked after elsewhere, and their home is unoccupied, it is exempt from council tax (Council Tax (Exempt Dwellings) Order 1992, SI 1992 No 558).

Staying at home

Enabling an elderly person to remain in their home with adequate support may be socially and economically preferable to a care home in some situations. Selling off a burdensome garden, renting out part of the house so that there is someone close at hand in an emergency, or paying a carer may facilitate this.

Taking in a lodger

Pensioners with suitable homes can receive up to £4,250 a year tax free from a lodger and their capital gains tax principal private residence relief is unaffected.

Selling off part of the property

Where the house has grounds not exceeding half a hectare (more if the house merits it), it may be possible to generate a tax-free lump sum by selling off part of the grounds for development, for example as a building plot, whilst remaining in the house. The sale is covered by the principal private residence exemption as long as the development land is sold before the house.

Carers

Paying for a third party carer or home help through an agency or the local authority has no tax implications. If the elderly person employs a carer, PAYE will need to be operated. If family members provide care (or other services) to a relative, it could be financially beneficial for them to be paid a commercial wage (or for their services). Although the recipient is taxable on the income it will be taken out of the elderly person’s estate for inheritance tax and age allowance purposes. The payments will also have depleted their savings if they later have to go into a care home. If the elderly person cannot afford to pay their carer, he or she may be entitled to taxable carer’s allowance depending on their other circumstances (currently £44.35 per week).

Providing a home

Those wanting to provide an elderly relative with a home could do so via an interest in possession trust. The property would be purchased, put into trust and the relative allowed to live in it rent-free for life. As there would be no income, there would be no income tax to pay. There will also be no capital gains tax or inheritance to pay when the property reverts to the settlor on the death of the life tenant.

The gain on a property purchased for a dependent relative and provided to them rent-free is exempt from capital gains tax if the relative occupied the property on 5 April 1988 and still lives there.

Legal matters

Elderly clients require legal advice on wills and powers of attorney to make life run smoothly for all concerned.

Powers of attorney

Ordinary and enduring powers of attorney (continuing in Scotland) enable a trusted representative to handle an elderly person’s financial and legal affairs. The document must be drawn up whilst the elderly person understands what they are doing. An ordinary power of attorney is usually drawn up as a temporary measure, for example, if an elderly person goes into hospital for an operation. Under an ordinary power of attorney the donor can still act on their own behalf and it can be cancelled at any time. If the donor becomes mentally incapable it becomes invalid. In contrast, an enduring power of attorney (EPA) is usually drafted to come into effect if the donor loses their mental faculties. In this event the attorney can take control of the donor’s financial and legal affairs (subject to any restrictions in the document) by registering the power with the Court of Protection. The Mental Capacity Bill introduced into the House of Commons on 17 June 2004 will replace new EPAs (probably from 2007 onwards) with ‘lasting powers of attorney’ encompassing health, welfare, legal and financial powers.

Wills

It goes without saying that elderly people should have properly drafted wills if they want to be sure that their property passes as they would wish to future generations and to minimise any inheritance tax liability. Some people are happy to have a will; others resist doing so believing that to draw one up may tempt fate. The importance of making a will and some of the problem areas were discussed In Nick Waterhouse-Brown’s two part article (TPT 2004, pages 109 and 117).

Approximately one million elderly people currently live in care homes or sheltered accommodation. With improvements in medical treatment this number is set to rise. Eldercare is already difficult to fund, resulting as it often does in the loss of the family home but matters look set to become much worse. As the birth rate falls and the percentage of young, working people declines, so will the revenue raised from taxation (unless taxes are increased). As a result there will be increasing pressure on local authorities to refuse care home funding. Inadequate pension provision combined with record levels of personal borrowing will make financing care in later life extremely difficult. Over the next few years eldercare looks set to become a significant political issue. New solutions such as tax breaks for carers and those making their own arrangements need to be considered. Sadly, there are no simple answers as to the best way to look after elderly relatives or finance their care, and not surprisingly tax considerations often take a back seat.

SARAH DEEKS LLB FCA

Originally published in, and reproduced with the kind permission of, LexisNexis Butterworth’s Tolley’s Practical Tax Newsletter