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In the seventh of a series of extracts adapted from his eBook 'Hutton on Estate Planning' (3rd Edition), Matthew Hutton looks at Inheritance Tax (IHT) planning arrangements involving life assurance and pensions.

Life Assurance

The classic use of life assurance is to build up, outside the chargeable estate, a fund which can be used to pay at least part of the IHT burden on death. There is a wide variety of different types of life assurance policy. The ‘traditional’ product for spouse/civil partners or civil partners is the so-called ‘joint lives and survivor’ policy which would pay out on the second death, the spouse/civil partner exemption removing any IHT liability on the first death. 

While it is no longer generally possible to obtain Income Tax relief on premiums paid on new policies, the payment of annual premiums within a donor’s financial 'comfort zone’ might be regarded as a sensible investment.

In capital terms, property is being extracted from the ultimate chargeable estate to fund a growth investment, also outside that estate, to meet part of the ultimate liability. The policy should of course be written in trust, to avoid the policy proceeds falling into the chargeable estate, typically for a class of beneficiaries, and so each premium is a gift which might be protected by either the £3,000 Annual Exemption, or the Normal Expenditure Out of Income Exemption from IHT.
 
For those who are minded to do something a bit more adventurous, there are three particular ‘products’ promoted by the life assurance industry which HMRC have confirmed are effective to avoid both the Gifts With Reservation (GWR) and Pre-Owned Assets (POA) regimes, even though some benefit or possibility of benefit is retained by the donor/settlor. Of course, the use of trusts in such cases has been rather curtailed by FA 2006, since no-one will want to incur an immediate IHT liability at 20% of the excess of the chargeable transfer over the Nil-Rate Band threshold. But such products, namely the gift and loan arrangement, the discounted gift trust and (in my view, to a lesser extent) the flexible reversionary trust, remain attractive in principle. It will be important to be able to form a positive view on the likely investment performance of the fund(s) underlying the policy.

Pensions

The regime introduced from 6 April 2006 to take the place of a good eight or nine different regimes which preceded it, whether retirement annuities or personal pensions, has rather changed the landscape.

FA 2009 has, for high earners, significantly cut down the generous Income Tax relief previously given on pension contributions, that is, up to the lesser of the individual’s net relevant earnings and the contribution limit for the year (£245,000 for 2009/10 and £255,000 for 2010/11). Looking forward, as from 2011/12 (with transitional anti-forestalling rules for 2009/10 and 2010/11), 40% higher rate relief was to have been restricted to those with taxable incomes not exceeding £130,000, with marginal relief for incomes up to £180,000. However, the Coalition Government’s Budget on 22 June 2010 indicated that the regime projected by the previous government to take effect from 2011/12 will be revised: details are awaited following the issue of a discussion document by HMRC on 27 July 2010. [Of course the main details regarding pensions were published in the run-up to the Comprehensive Spending Review: the annual 'contribution limit' will fall from £255,000 to just £50,000; the new higher multiplier proposed for defined benefits schemes may penalise employees with relatively modest salaries/pension increases; but at least there are no plans (currently) to restrict the marginal rate of tax relief for persons paying at higher/additional rates - Ed]

When it comes to taking the benefits, apart from the well-established option of income drawdown as an alternative to converting the whole fund into an annuity on retirement, there is under the FA 2006 regime the possibility, on reaching age 75 with funds still left in the pension pot, of taking out an ‘Alternatively Secured Pension’ or ASP. However, as from 22 June 2010 the limiting age has been increased to 77 and it is due to go altogether from 2011/12.

While any funds remaining at death can be used to pay pensions to a surviving spouse/civil partner or financial dependent, it has been made clear that any money ultimately left after the deaths of all such individuals cannot effectively be used to mitigate IHT. In particular, one option has been closed off by FA 2007: it is not possible to transfer money into the pension pots of other scheme members. However, as from 22 June 2010, the combined Income Tax and IHT charge of 82% which could apply to residual funds on death has been reduced to just an Income Tax charge of 35% for the remainder of 2010/11, due to be increased to 55% from 2011/12.

The above is an adapted extract from Hutton on Estate Planning 3rd Edition.

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