Personal finance: Scheme can help to cut inheritance tax

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Regular readers of this column will know how frequently the thorny issue of Inheritance Tax comes up in my post bag, so anything that can help to reduce the burden of this awful after-death tax is always welcome news, writes Nick Plumb.

One particular company called Octopus (yes that really is the name of the company) have a remarkable investment-based inheritance tax planning product that deserves a mention.

Most people want to protect their hard-earned savings and property assets and pass them on to their families. Nobody likes the idea of paying out up to 40 per cent of their money to the tax man after they die, but of course, that’s exactly what can happen if you don’t plan ahead. When you die, Her Majesty’s Revenue & Customs (HMRC) can claim up to 40 per cent of your estate above the threshold of £325,000 (the tax free allowance, now frozen until 2015, known as the ‘Nil Rate Band’) or £650,000 for married couples and civil partners.

I have previously detailed a number of ways to limit exposure to inheritance tax, such as the use of discounted gift trusts. However, these typically take seven years to be fully effective and are relatively inflexible, with investors having to decide at outset what level of income they will require for their remaining lifetimes.

Unlike direct gifts and transfers, which take seven years before they’re fully exempt from inheritance tax, investments into the Octopus Inheritance Tax Service are exempt after just two years (provided the investments are still held at the time of death). This is because the Octopus scheme invests directly into unquoted limited companies. Those holdings qualify for Business Property Relief, which means that the investment is exempt for inheritance tax purposes after only two years.

An investment in Octopus ITS does not involve complex legal structures, client underwriting or medical reports. More importantly, unlike most other inheritance tax solutions, you retain access to your investment capital. If your circumstances change and you want to access your money, you can have it. However, obviously any money withdrawn from the product will no longer be shielded from inheritance tax and will fall back into your estate as soon as you take it out. Investors also have the option to take a regular withdrawal from the product or leave any returns invested. The targeted return is 3 per cent per annum.

As an example; Harry has an estate (including his house, investments and savings) of £825,000 that he would like to leave to his only son, George. Assuming that Harry has a single person’s Nil Rate Band of £325,000 and he does no IHT planning, the inheritance tax bill faced by George will be £200,000, equivalent to almost a quarter of his father’s assets. Harry is 75 years old and is not in the best of health, so he is concerned that if he makes a gift into a discounted gift trust, he may not survive for the full seven years and George will still have a large inheritance tax bill to pay. Harry has therefore been looking at ways in which he can reduce the inheritance tax bill for George.

Faced with this situation, Harry decides to invest £200,000 into the Octopus Inheritance Tax Service. After holding the investment for two years it qualifies for Business Property Relief and Harry’s investment is completely removed from his taxable estate, reducing the inheritance tax bill faced by George by £80,000.

The Octopus ITS investment can also be written into a trust, so if Harry wrote his investment into trust for George, on Harry’s death, George would have a capital sum available from which he could pay any remaining inheritance liability on Harry’s estate – in this case £120,000.

The scheme is also very flexible. Harry can withdraw money during his lifetime without it affecting the inheritance tax relief he will receive on his remaining Octopus ITS investment.

However, this type of investment should only be considered by those with significant liquid capital sums and healthy cash reserves. The Octopus ITS is not an investment that everyone will be comfortable with, as like any non-cash investment, there is an element of risk. Octopus set a targeted return of 3 per cent per annum, but this is NOT a cash investment and there is therefore a risk that the targeted return may not be achieved. Because the Octopus scheme invests directly into unquoted limited companies, your capital is not guaranteed. This means that the value of your investment may go down as well as up and you may not get back the full amount invested.

Like any investment or tax planning product, it is best to seek independent advice on your own position and requirements before making any decisions.

-- Nick Plumb is an Independent Financial Adviser and Practice Principal at Plumb Financial Services. Post your questions to Nick at Plumb Financial Services, Baylham Business Centre, Lower Street, Baylham, Suffolk, IP6 8JP, e-mail nickplumb@aol.com, or telephone Nick on 01473 830301. Nick’s opinions and views in this column are provided only as a general guide and do not constitute personal financial advice. Any readers who require advice should contact Nick to arrange a complimentary initial consultation to discuss their own position and requirements. Plumb Financial Services is regulated by the Financial Conduct Authority.