February 15th, 2008
Where there’s a will there’s a way
The Chancellor Gordon Brown’s most recent Budget grabbed few headlines but have forced many to reconsider how best to protect their inheritance.
The aftermath of the Budget is often a good time for people to review their finances and make the necessary adjustments to their tax planning. Gordon Brown’s 10th annual financial statement was widely regarded by the media and experts as relatively neutral.
There were no major headline changes to income tax rates with income tax bands rising in line with inflation - the threshold over which 40 per cent income tax is paid, for example, rising modestly from £32,400 to £33,400. The capital gains tax annual exemption (what you are allowed to gain tax free through the disposal of assets) was similarly raised only from £8,500 to £8,800.
However, while there was nothing particularly headline grabbing about Mr Brown’s statement there were some changes that could have quite significant implications for even the modestly wealthy wanting to pass on their estates to children or grandchildren through trusts that may lead many to have to redraw their wills. The Chancellor also announced that a new vehicle for investing in the property market, Real Estate Investment Trusts, would be launched in January 2007.
There were also changes to the rules of investing in small companies through Venture Capital Trusts, which are proving increasingly popular for investors. These serve to make such investments marginally less attractive but only just.
What he was aiming to do was target people like the Duke of Westminster but by taking this blunderbuss approach he has affected everyone
Mr Brown at last confirmed the final details of the new A-day pension regime which began on April 6, clarifying, in particular, the inheritance tax rules for those not buying an annuity with their lump sum.
If there is a major headache for many in this Budget it is in the area of trusts which the Society of Trust and Estate Practitioners estimate could lead to one million wills having to be redrafted. The Government insists that the “changes will only affect a very small number of very wealthy people” but even modest estates will be affected by the changes.
Many also remain baffled as to why the Chancellor has chosen to radically alter the tax treatment of trusts since as a measure it only raises £15 million and, particularly, since the professional costs of redrafting all those wills could be as much as £250 million. “He would be raising more on the VAT on those fees than he would from the actual measure,” says John Whiting, tax partner at PricewaterhouseCoopers.
For many years trusts have been used by many to pass on their wealth to the next generation. Grandparents may set up a trust for their grandchildren, for example. They may put into it property, shares or some other asset. The beneficiary might then receive a lump sum of what was accumulated in the trust at the age of 25.
They would usually set one up by making a visit to a family solicitor and, while often the sum involved might often be around £100,000 or more, in many instances it can be as little as £10,000. Trusts are seen by many as an essential mechanism for protecting and managing family funds.
The Chancellor is concerned, however, that many people are using trusts as an inheritance tax dodge and has decided to impose stiffer taxes on them.
So what are the changes?
- Lifetime gift payments into the main types of trust will be subject to an immediate inheritance tax charge of up to 20 per cent over the new nil rate band of £285,000 over which this tax is paid. Previously they weren’t taxed if you survived seven years.
- Assets held in some trusts will be subject to a charge of six per cent every 10 years or when the funds are distributed to beneficiaries.
- Assets that are passed on death into a trust for the surviving spouse (which might be the family home being placed in what is called an Interest in Possession Trust) could be subject to inheritance tax of up to 40 per cent unless certain rigid rules are met.
- Some trusts will become subject to 10-yearly and exit charges from April 6 2008 unless the terms of the trust are changed so that the beneficiaries become entitled to the trust assets at 18.
This latter change, making the assets of trusts available to 18-year-olds, worries many. “This seems a measure primarily benefiting the wine bars and the DVD shops,” adds Whiting at PricewaterhouseCoopers. “The Government is saying that people at 18 are adult. You have only got to try and obtain car insurance for an 18- year-old to realise that the insurance industry certainly does not regard an 18-year- old as adult.”
Mark Warburton, tax partner at business advisers Grant Thornton, says the Chancellor has been out to get the rich but has aimed his fire at everyone. “What he was aiming to do was target people like the Duke of Westminster but by taking this blunderbuss approach he has affected everyone.”
But what should you do in response if you have existing trust arrangements or are planning on setting up a trust? It is important to seek out advice. These changes are what were announced in the Budget and may have since been modified in the Finance Act, although at the time of writing few expected significant changes.
Brian Tora, investment communications director for Gerrard Investment Management, one of the leading wealth management companies in the UK, says those with trusts should take a cautious approach. “I think people should do as little as possible until it is passed into law and we know what the full picture is. The only people it seems to benefit are the lawyers who will be having to redraft all the trust documents,” he says.
There were also some interesting measures for investors looking for other places to put their money in the Budget. The Chancellor announced that Real Estate Investment Trusts (REITS) will become available to invest in from January 2007.
These are a new vehicle to invest in property without having to set up your own buy to let portfolio. Individual investors will buy shares in these trusts which will then be traded on the Stock Market. They will also be a tax efficient way of holding property. There are similar types of funds in Japan and France, where they have proved popular with investors.
The Chancellor also tightened the regime for investing in Venture Capital Trusts which have proved a very tax efficient way of investing in small companies. Anyone investing in these trusts, which are widely offered and often mainly invest in AIM (Alternative Investment Market) listed companies, previously got 40 per cent tax relief (whether or not they were a higher rate tax payer) on any money they put in up to £200,000. This has been reduced to 30 per cent. The length of time you have to hold VCTs to get the tax benefits has also been increased from three to six years.
Given the strength of the AIM market in recent years these remain some of the most tax efficient investments around.
The Chancellor also confirmed the final arrangements for the so-called A-day new pension regime which came into existence on April 6. The final arrangements have been surrounded by controversy since he performed a massive U-turn in December.
Holidays homes and other residential property as well as alternative investments such as paintings, fine wine, whisky and vintage cars were all going to be eligible investments. However, the Chancellor changed his mind and spoilt everyone’s fun much to the chagrin of the financial services industry who were about to launch such pension products.
The new rules allow anyone to invest a sum up to the value of their entire salary so long as that doesn’t exceed £215,000 in any one year. They can also invest up to £3600 a year if they don’t earn anything at all. You are also allowed to have a pension pot as large as £1.5 million tax free in this financial year, rising to £1.8 million in 2010-11.
The new regime will also mean that you will no longer be forced by the age of 75 to buy an annuity with your pension. Instead the lump sum can become an Alternative Secured Pension from which you can make draw downs.
In the Budget, the Chancellor clarified that any lump sum left would be subject to inheritance tax on the death of the holder. As a result of the changes many people may now consolidate their pension investments into a Self Invested Personal Pension where they, in effect, become their own fund manager. “The SIPP is likely to become the personal arrangement of choice because it will give people more control over their retirement investment,” adds Tora at Gerrard Investment Management.
Apart from the unexpected attack on trusts – seen as one of the Chancellor’s famous stealth moves – there were no major tax alarms in the Budget, although they can’t be discounted in future if the Chancellor is to have the revenue to fund growing public expenditure.
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