Stuart and Pamela are married and in their late 70s with independent, grown up children and several grandchildren and great grandchildren. They are both retired and are generally in good health, although Stuart has had health issues in the past. Their only income was their State Pension and they had no other savings or investments. They lived in a council house.
They had lived a relatively simple and quiet life until they received an unexpected windfall of £2.5 million, which has completely transformed their lives. They came to Mazars Financial Planning via a referral from Mazars’ private client tax team.
Stuart and Pamela had several ideas of what they wanted to do with their £2.5 million windfall. Making gifts to family was very important to them. They also wanted to buy their council house and then use the remaining funds to enjoy life.
When Stuart and Pamela first came to see us they brought with them their daughter and a cousin. It soon became apparent they had a large family. Stuart and Pamela made it clear to us that they wanted to make outright gifts to family with some of their windfall proceeds. We needed them to decide how much they wanted to keep aside for gifting and it became clear at our first meeting that certain family members were very keen to get involved in the gifting aspects of the planning and a conflict of interests was developing between family members. Stuart and Pamela knew how much they wanted to keep aside for gifting, but it was the breakdown of who got what that was causing the conflict. As Stuart and Pamela were our clients, we arranged to meet with them on their own and we agreed that whilst it was good to involve certain family members in the decision making process, it was also creating conflict. We agreed that going forward their daughter should be the only family member involved in the process as she was closest to her parents and had influence over the other family members. By the time of our next meeting the family gifting issues had been resolved.
We also discussed other issues with Stuart and Pamela which included the importance of providing cover for future financial liabilities such as care home fees. We also made them aware of the significant inheritance tax (IHT) liability that would result upon their death. Stuart and Pamela were concerned about the IHT liability, particularly as they wished to make large gifts to family. They did not realise that the gifts would be potentially exempt transfers (PET) and may become chargeable to IHT if they died within seven years of making the gifts. They did not want their family to be liable for any potential IHT charge.
We discussed that if no IHT planning was taken with their £2.5 million windfall, that their IHT liability after taking account of both of their nil rate bands, would be £740,000. We then discussed suitable potential IHT solutions which included insuring against the liability, making gifts directly or through trusts and investing into exempted assets.
We provided indicative quotations for the cost of insuring against the liability, but Stuart and Pamela confirmed that for personal reasons they did not wish to consider life cover as part of their IHT planning.
Stuart and Pamela confirmed that their objectives for their windfall were:
- To create an inheritance tax efficient plan, whilst ensuring they have always got access to more than sufficient funds to enjoy their windfall
- In addition, whilst mitigating IHT was important, they did not want their beneficiaries to be burdened with any IHT liabilities
- They also wanted their funds to be invested in a flexible manner
We carried out a risk profiling exercise which confirmed Stuart and Pamela as overall medium risk investors with regards to the funds being invested. We agreed we would retain sufficient funds in cash to maintain their standard of living throughout their life and to ensure that there are plenty of funds available for care home costs should that be required. With the remainder of the funds to be invested we would invest the majority in cautious investments, with a small proportion of surplus investments in high risk investments. Stuart and Pamela agreed they would be prepared to take a higher level of risk with surplus funds to invest in products that had specific inheritance tax benefits.
We also agreed with them that their capacity for loss was high as, after receipt of their windfall, they have significant assets to allow them to live comfortably for the rest of their lives. If they were to lose some of the value of the investments being proposed this would not impact on their standard of living.
Funds to be retained in cash
We agreed they would retain a total of £420,000 in cash: £100,000 for their emergency funds and short term spending; £20,000 to buy their council house; and £300,000 to cover their medium to long term requirements including potential care home fees. This cash will also provide the initial source of funds to pay any potential IHT liability in the event of their death in the short term.
Outright gifts to family
They then wanted to gift £830,000 outright to family.
We explained that these gifts would be PETs and would be chargeable to IHT if they died within seven years of making the gift. As we planned to use their IHT nil rate bands for establishing trusts for each other, as detailed below, the gifts should not be made until after the recommended trusts were established.
We then carried out a cashflow modelling exercise and Stuart and Pamela confirmed they were happy to invest the remaining £1,250,000 as IHT efficiently as possible.
Establishing Reciprocal Life Rent Trusts
Acting on advice from the Mazars Tax and Trust department we recommended they establish two reciprocal life rent trusts for each other for £325,000 each. These trusts would allow them to each take capital or income from the trust that the other person had set up for them. By each gifting £325,000 into trust meant there would not be an immediate tax charge as this is the amount of each of their IHT nil rate bands.
These trusts would ultimately be for their beneficiaries, and would be free of inheritance tax after seven years, however, they could be accessed by Stuart and Pamela, subject to the restrictions of the trust deeds, therefore they provide the flexibility required.
We recommended that the trust funds were invested in a professionally managed cautious investment portfolio utilising Mazars’ investment management service.
Investment into a cautious risk rated investment portfolio
We recommended £300,000 be invested in a professionally managed cautious investment portfolio. The purpose of this portfolio was to provide growth potential whilst maintaining access to capital and/or income in future should it be required. The portfolio would also be available for any IHT liabilities in the event these became payable.
This portfolio also had the flexibility to accept further future investments should Stuart and Pamela’s circumstances or attitude to risk change.
We recommended an amount of £300,000 (12% of the total windfall) as this was a relatively small amount of the portfolio which would be exposed to a cautious level of investment risk.
Exempted asset recommendations
Although Stuart and Pamela were overall medium risk investors and elderly clients, their large windfall meant their capacity for loss was high. Ensuring they held sufficient assets readily available in cash to meet their short and medium term requirements, meant we had scope to invest a small proportion of their surplus assets in high risk inheritance tax efficient schemes, to meet their IHT objectives.
We therefore recommended the remaining £300,000 was invested in IHT specific plans which invest into assets that benefit from Business Property Relief (BPR), which is exempted from IHT after an initial two year qualifying period. These BPR investments would allow Stuart and Pamela to retain ownership and control of the invested funds, whilst removing them from the value of the estate accessible to IHT. These assets could also be accessed if required, although ideally should be held until death. Any growth of the funds is immediately outside of the estate for IHT.
We recommended investment into four different IHT investment schemes in order to add diversity to their investment portfolio and to reduce the impact of any one manager underperforming. One of the schemes was an Inheritance Tax ISA which meant Stuart and Pamela were utilising their annual ISA allowances.
We made it clear to Stuart and Pamela that these were high risk investments as they tend to invest in smaller companies. This high risk was balanced out by the fact that we had already retained sufficient assets readily available in cash to meet their short and medium term requirements; and the trusts and investment portfolio were to be invested in cautious risk rated portfolios. Stuart and Pamela were comfortable with this as the exempted assets investment amount was surplus funds, which accounted for a relatively small 12% of their total windfall; and IHT efficiency was an important objective to them.
What happened next…
Stuart and Pamela had never previously needed financial advice and the whole process was new and daunting to them. They said they really valued the time we had taken to meet with them and their daughter. As a result Stuart and Pamela were keen to implement our recommendations as soon as possible to give them peace of mind regarding their potential IHT liabilities. They proceeded with all of our recommendations, taking care to establish the trusts before making the family gifts.
They met separately with Mazars’ tax and trust department who established the trusts for them.
On our advice they appointed a solicitor, ensured updated wills were made and appointed a lasting power of attorney.
We scheduled our first post implementation meeting with them six months after our first meeting, and thereafter will be meeting with them at least annually to review their circumstances and investment portfolios.