Asset conversion – as opposed to asset reduction – allows the individual to retain full ownership of (and therefore access to) the investment during their lifetime, yet qualify for Inheritance Tax (IHT) relief after only a two year period. The investment is generally restricted to “qualifying” assets, whether assets which attract Business Property Relief (BPR) or Agricultural Property Relief (APR), or investing in pensions.

BPR and the Alternative Investment Market (AIM)

AIM is a sub-market of the London Stock Exchange which allows smaller companies to float shares. An AIM portfolio qualifies for BPR after a two year qualifying holding period and so may be suitable for:

• Those who are elderly or in poor health and so need to reduce an IHT liability within a relatively short time period
• Those with dormant cash held within a business which may not qualify for BPR
• Those who have lost the mental capacity to manage their financial affairs. An Attorney or Deputy does not have power to make gifts (or “investments” with a gift element such as a Gift & Loan Trust, a Discounted Gift Trust or a Flexible Reversionary Trust) without a specific Court Order, but can invest into BPR qualifying investments
• Those who want to transfer more than the nil rate band to a discretionary trust without incurring the IHT entry, anniversary and exit charges
• Those who are the life tenant of an interest in possession trust (otherwise known as a life interest trust). The value of the trust fund forms part of the taxable estate on death, and so investing in BPR qualifying assets can result in the trust fund being IHT exempt
• Those who have sold a business or farm. When the individual sells the business or farm, the sale proceeds form part of the taxable estate (because BPR or APR will be lost). If the sale proceeds were reinvested (within three years of the sale) into a BPR qualifying investment then BPR will be maintained or the previous entitlement to APR will effectively become an entitlement to BPR. The new asset does not need to be held for another two years due to the availability of Replacement Property Relief, provided the original agricultural asset would have attracted BPR in its own right
• Those couples who need (due to the size of the estate) to receive IHT benefits twice on the same capital. An AIM investment is made which is then specifically left in a Will to a discretionary trust on the death of the first spouse. The surviving spouse then borrows the capital from the discretionary trust, so that the only asset remaining within the trust is a debt or an “IOU”. The surviving spouse then retains the asset for a further period of two years when it will qualify for BPR, yet the debt / IOU is still owing to the trust which reduces the value of the surviving spouse’s estate, so long as it is actually repaid

AIM shares may have a relatively high risk profile, and may prove difficult to sell. For relatively cautious investors, there are investment products which invest in an AIM portfolio which is specifically selected to minimise risk to capital. The potential disadvantage of aiming for capital security is that returns are likely to be reduced, and the issue with achieving a quick sale when required is likely to remain. It is possible to take out insurance to protect the investment against loss, and also to protect the individual’s estate against IHT should they die before the end of the two year qualifying holding period.

APR and forestry or agricultural assets

Investing in commercially-managed woodland should qualify for 100% relief from IHT after two years. These arrangements also offer tax-efficient investment growth, as any increase in the value of timber and plantations is exempt from Capital Gains Tax (CGT); and income generated from commercial woodlands is also generally exempt from income tax. It is possible to self-invest or invest indirectly through a professionally managed investment. These investments may prove difficult to sell and it may not be possible to realise an investment until the underlying property is sold.

Pensions

The law in relation to pensions is complex, and so the general information provided here can only ever be viewed as generic advice, with specific advice available on request.

Contributions to a pension scheme

Contributions to a pension scheme will be immediately excluded from the individual’s estate if the contributions are made whilst the individual is under the age of 75 and likely to survive to take their retirement benefits (which essentially means contributions made more than two years prior to death).

Death benefits

Where the individual’s estate is entitled to the value of the death benefit from the pension fund, it would normally form part of the individual’s taxable estate. If instead the individual were to assign the death benefits, during their lifetime, to their chosen beneficiaries then the death benefits are generally not subject to IHT on the individual’s death.

An assignment of death benefits is treated in the same way as any other gift, and so it may form part of the estate on death. However, if the assignment occurs whilst the individual is likely to survive to take their retirement benefits (again, which essentially means more than two years prior to death), then the value of the transfer should be nominal.

If an individual dies before reaching age 75, there will generally be no tax charge on death benefits paid in lump-sum form. If an individual dies after reaching age 75, the recipient of death benefits will be able to make lump-sum withdrawals subject to the special lump-sum death benefits charge at the rate of 45% (2015/2016) or at their marginal rate of tax (2016/2017 onwards).

Death benefits written in trust

Any pension lump sum death benefit paid to a beneficiary will form part of that beneficiary’s taxable estate in the event of their later death. This is of particular relevance where the beneficiary is the surviving spouse. The solution to this problem is for the individual to set up a trust external to the pension scheme – commonly called a “Pension Death Benefit Trust” or “(Spousal) Bypass Trust” – and make an expression of wish to the pension scheme trustees that they pay the death benefit to the external trust.

Pension Death Benefit Trusts only relate to any death benefit paid from the pension scheme, and so in no way affect the ability to take benefits from the pension scheme during the individual’s lifetime.

The Pension Death Benefit Trust is written as a discretionary trust, and the widely defined group of beneficiaries would typically include any surviving spouse, children and grandchildren. A discretionary trust is one where no beneficiary has a right to income or capital from the trust fund. Instead, as the name suggests, the trustees have the discretion to decide how much income or capital (if any) to pay to each of the beneficiaries but without the value of the trust fund forming part of their estate for IHT purposes. Whilst it is possible to guide the trustees on how to exercise their discretion by preparing a Letter of Wishes, the ultimate decision on how (or even whether or not) to exercise their discretion rests with the trustees. Trustees must act unanimously, and so just one trustee may have the ability to prevent payments from the trust fund even if all the other trustees agree. Choice of trustees is therefore crucial.

Historically, to avoid IHT anniversary and exit charges applying to the Pension Death Benefit Trust, the individual could set up a number of trusts (known as “Pilot Trusts”) during their lifetime, and divide the death benefit between the Pilot Trusts given that each trust had its own nil rate band. However, since 6 April 2015, the same-day addition (SDA) rules prevent settlors from obtaining IHT advantages by increasing the value of assets in more than one trust on the same day. The exceptions are where the trusts were created before 10 December 2014 and the settlor makes no additions on or after that date; or where the settlor makes additions by Will on his death before 6 April 2016 without changing his Will on or after 10 December 2014.

Withdrawing pension benefits in retirement

From April 2015, the majority of restrictions on accessing savings from certain pension schemes have been removed. Members at normal retirement age will be able to access their pension fund in full without the need to purchase an annuity; and they will be taxed at their marginal tax rate on withdrawals from the pension fund.