Using a flexible reversionary trust to reduce inheritance tax whilst retaining access to capital

The simplest method to reduce inheritance tax (IHT) is to make outright gifts to chosen individuals. The current recessionary environment will undoubtedly reinforce the natural tendency for people to hold onto their capital or assets to ensure they do not compromise their future financial security. Furthermore, many people are not comfortable passing outright control of assets to beneficiaries.

Therefore, the ideal solution would seem to be one where one can achieve the IHT savings of a normal gift, whilst continuing to have access to capital and ensuring that beneficiaries do not take immediate control of the capital. Unfortunately, governments at either end of the political spectrum have enacted legislation to prevent people ‘having their cake and eating it’. The ‘reservation of benefit’ and ‘pre-owned asset’ rules have severely limited the scope to make IHT effective gifts whilst retaining access to an income or capital. Discounted gift trusts and loan trusts are some of the few ways to achieve this goal, but usually by sacrificing future flexibility or with reduced tax efficiency. There is a third way, the ‘flexible reversionary trust’ such as the WAY Flexible Inheritor Plan, Canada Life Wealth Preservation Account and IOMA Estate Control Bond.

With discounted gift trusts you lose all access to your capital and any investment growth, whilst the income level is set in stone at outset. Few people would normally choose an investment with such restrictions, as is shown by the general antipathy to annuities which have similar features. Why commit to a fixed income and no access to capital when you don’t have to?

Loan trusts only remove any future investment growth from the estate, as the loan is repaid over a number of years. The paradox of loan trusts and discounted gift trusts is that the loan repayments and income payments are returned to the donor’s estate; unless these monies are spent the IHT liability will simply build up again. The flexible reversionary trust allows you to structure your future income and capital needs to your exact requirements, but more importantly provides the flexibility to change them in the future.

How does it work?

You can invest up to a maximum of your remaining nil rate band (£312,000 for 2008/09) per person into trust for specific individuals. You ‘carve-out’ a series of reversions which are due to be paid back to you during your lifetime, e.g. 10% of the initial investment plus any growth for 10 years. In the normal course of events, these reversions would be paid to you and the trust depleted after the ten years. The flexibility of this trust comes through the ability of the trustees (selected by you the investor) to defer any reversions to future dates. In this way, you are not committed to receiving a fixed ‘income’ from outset. Reversions can be deferred indefinitely allowing the trust fund to grow. If all reversions are deferred then after seven years the full trust value will be outside your estate, yet you will retain access to 100% of the trust value through future reversions. Importantly the trust is flexible enough for capital to be paid to any potential beneficiaries at any stage. This level of flexibility is simply not available from other planning solutions.

Investment flexibility

Discounted gift and loan trusts are virtually always offered via life assurance bonds as the investment. The flexible reversionary trust can be utilised with unit trusts or life assurance bonds. This offers significant tax planning opportunities as unit trusts can take advantage of the reduced capital gains tax rate of 18% whereas all growth within an offshore life assurance bond will be taxed up to 40% for a higher rate taxpayer. For a tax comparison of discounted gift, loan and flexible reversionary trusts please click here.

Conclusion

Flexible reversionary trusts have been utilised for twenty years and use tried and tested principles which are not inflammatory to HMRC, a key aspect of any tax planning exercise. A married couple can remove £624,000 (2008/09) from their taxable estate after seven years, saving potential IHT of £249,600, whilst retaining potential access to the gifted capital plus any growth throughout their lives.

It is always surprising that reversionary trusts are not utilised more often. My concern is that so many people end up with inflexible discounted gift trusts or relatively ineffective loan trusts, when they could benefit from the flexibility of a flexible reversionary trust. The reality is that some financial advisers, particularly those tied advisers who are restricted to selling the products of only one life assurance company, only offer a choice of a discounted gift or loan trust, and their clients end up with the option which is least unsuitable. The message should be clear; always consult a specialist independent professional who can advise you on all types of planning including the flexible reversionary trust.

Email Christian Ward Subscribe by RSS or Subscribe by Email