Slightly awkward
by Doug Brodie
In this blog:
/1. Giving it all away: no one gets out of here alive
/2. Gifts into discretionary trusts – the tax consequences
/3. “Our team aim to respond to all emails within 11 working days…”
/4. Current annuity rates and how they have moved
/5. Cut your 40% / 45% tax on interest to 36% / 40% permanently
/6. Henderson International Income – what to do if you hold it
/1. Giving it all away: no one gets out of here alive
We need to teach our children well because they are our scientists who will discover cancer cures (more vaccines perhaps), mend our bones when we fall over, provide the treatment that for most of us will add one or two years extra, more than our forebears of 100 years ago, and they will hold our hand, or our children’s hands, when we lie dying. There is an inevitability that everything you own will at some time in the future, be taken over and spent by other people. For many, that means our kids and grandkids.
My wife and I have a house in France – not a quaint little gîte with Breton beams, more a 1973 two-storey house with cast concrete walls, but it’s 100 yards from the lake and its sandy beach, so for a boating/windsurfing/water-skiing/swimming family it’s ideal. We bought it in 2007 when they closed the local campsite, we’ve spent every family summer there since 1995 and our kids were 3 and 5.
We have two boys, they have wives/partners and three children of their own between them. Last summer the kids (as we obviously call them) were sitting out on the verandah late at night polishing off the bottles, my wife and I pretending to sleep upstairs. They were talking about when their kids become teenagers themselves, and what they would do when they come down to the house with their friends in another 14-odd years’ time; my wife and I realised then that our place in France isn’t really ours, it’s owned for the kids and for their kids. We never really own anything, we just collate and preserve items for the next generation(s).
So why not just give it all away to them now? Sure, things will and can go wrong, you need to have the right family environment to do so, but if you trust your kids to do right for you, for them and for the family in the future, pourquoi pas?
You can give the family home to them and simply rent it back – if you have the income. In that way the family home is out of the estate and they get an income stream (taxable) from you.
/2. Gifts into discretionary trusts – the tax consequences.
IHT
Lifetime gifts into discretionary trusts are chargeable lifetime transfers (CLTs).
IHT will be charged at the lifetime rate of 20% on the amount above the settlor’s nil rate band.
There is no 20% lifetime tax on discretionary will trusts as the estate pays the IHT at the death rate of 40% on amounts in excess of the available nil rate band.
If the settlor also pays the tax, this is regarded as a further gift, and the tax must be grossed-up to value the ‘loss’ to their estate. This gives an effective rate of 25%.
Once within the Trust, Inheritance Tax is charged on the value of the Trust assets (above the NRB) on every 10 year anniversary ('periodic' or 'principal' charge). The maximum Inheritance Tax charge every ten years is 6% (which is 30% of the lifetime rate of 20%).
And when capital (not income) is distributed out of the Trust to the beneficiaries, again at a maximum of 6%.
CGT
Lifetime gifts of existing assets into trust, other than gifts of cash or the assignment of investment bonds, will be disposals for CGT.
Any gains will be assessed on the settlor unless they elect to ‘holdover’ the gain.
Holdover is available because the transfer to trust is also a chargeable transfer for IHT.
Holdover relief is not available where the settlor, their spouse/civil partner or their minor (under18) unmarried child can benefit from the trust (these are known as 'settlor interested' trusts).
If the trustees dispose of trust assets, the gains are calculated in the same way as for an individual and taxed at the trust rates of CGT.
The trustee rate is now 24% on all assets (20% or 28% in 2023/24).
If the disposal was before 30 October 2024 the trustee rates were 20% and 24% on residential property.
The trustees are only entitled to half the individual annual CGT exempt amount.
However, this exemption is shared equally between all trusts created by the same settlor, subject to a minimum of one-fifth of the trust exemption.
There will be a CGT disposal if the trustees transfer chargeable assets to a beneficiary.
This could happen if the trustees make a discretionary payment of capital to a beneficiary.
Income Tax
The Trust Income is charged to tax at the Trust Rates which are currently 39.35% on dividends and 45% on other income.
If a distribution of income is made to a beneficiary, there is a 45% tax credit on that distribution.
The Trust must have paid sufficient tax to meet this tax credit. Where the tax credit exceeds the tax paid by the Trustees, then the Trustees must pay the difference as part of the Self-Assessment process.
Bare Trusts
IHT
When assets are placed into a Bare Trust they are considered as PETs (potentially exempt transfers) for Inheritance Tax purposes.
Therefore, the Settlor must survive for seven years following the settlement of the assets for the PET to become wholly outside of the Settlor’s taxable estate.
Since the capital and income of a Bare Trust belong to the Beneficiary, they are responsible for any Inheritance Tax that may be due.
However, any growth on the assets within the Bare Trust is deemed outside of the Settlor’s estate.
During the lifecycle of the trust, when Trustees are responsible for the trust assets, there will be no Inheritance Tax charges on the trust itself.
This is because a Bare Trust is not a ‘relevant property trust’, and therefore not subject to ten-yearly periodic charges or exit charges after the assets are transferred to Beneficiaries.
However, although there are no exit charges when the trustees transfer assets to a Beneficiary, the value of the Bare Trust will always be included in the estate of the Beneficiary for inheritance tax purposes from the moment the Bare Trust is created.
CGT
Bare trusts are often created either by a transfer of cash to the Trustees or the transfer of existing assets, such as insurance bonds, share portfolios or other investment funds.
There are no Capital Gains Tax liabilities for these lifetime gifts involving cash or existing bonds.
However, if other assets are transferred into trust while the Settlor is still alive, this will be a disposal for capital gains tax purposes, and tax on the gain itself will be treated as responsibility of the Settlor.
Where assets in the Bare Trust are disposed of, the tax liability is the responsibility of the Beneficiary, not the Settlor.
Income Tax
Investment bonds do not produce an income. As a result, there is no Income Tax charge to be paid on investment bonds within a Bare Trust, unless money is withdrawn from the bond wrapper and a chargeable event occurs.
Investments within the bond wrapper can be reviewed and changed without the need for the Beneficiary (or the Trustee) to complete a Self-Assessment tax return.
This means parents will often use bonds as the investment within a Bare Trust for their children (as minor Beneficiaries) as Income Tax on the gift can be deferred until they reach 18 (at which point gains will be taxed on the Beneficiary of the trust).
/3. “Our team aim to respond to all emails within 11 working days…”
Without any political inference whatsoever, all the institutions in our industry are stymied for staff. When a new client comes to us the average number of pensions they hold is three, and then there are ISAs, spouse contract et al. We are required to compare contracts and document this work for advice and compliance purposes.
Back in the day, it used to be three working days – now even AJ Bell say they intend to ‘address’ emails in 2-3 days, never mind resolving the requests. Worse, one of our bond providers now has a 25-day turn around period (that’s five weeks to you and me). I’m sorry this takes a long time, it just does. We could jump into the proverbial bed with just one provider but that would not be independent, and you could go to PensionBee, HL or ii as they do not give advice so don’t care if your old scheme is/was better value with better options – and they have no liability to you whatsoever in any transfer you do.
The joy of being independent is that you, the client, can see any product from any company compared and assessed. We have client money in Scottish Mortgage, Vanguard ETFs, Fundsmith Equity, and S&P trackers – we are product and fund agnostic, our objective is to ‘liability match’, that way you get very predictable income, your own private defined benefit scheme.
/4. Current annuity rates and how they have moved.
/5. Cut your 40% / 45% tax on interest to 36% / 40% permanently.
In putting together the different elements of an investor’s portfolio we always start with the wrapper – the account that the investment will be contained within. A SIPP isn’t an investment, it’s an administrative account that complies with the regulations for pensions, however, it is empty. The investor has to choose what investments to hold within the SIPP. The same is true for an ISA, however, once you have filled your allowances for both, what do you do next with investment money that can’t be put in these wrappers?
We are still seeing client portfolios brought to us from stockbroking or direct (HL, ii) platforms where investments have been allowed to grow unwrapped. Just last week we took over a client portfolio from a large, listed investment / wealth manager and in the middle was a holding in the stockbroker favourite Findlay Park American – the problem? The client cost was £200k and the current value is £400k – the client is stuffed in terms of how to tune her portfolio to provide the income she needs, and we think it is simply lazy to leave holdings like this to grow. The stockbroker should have provided the discipline to have the client take a little bit of CGT on the chin each tax year so that, when necessary, the holding could be switched.
For the right client circumstances we use bonds as wrappers – technically these are single premium life insurance policies, and it is that aspect that makes them a brilliant ‘next best thing’.
Get a permanent income tax discount.
Bonds have several technical oddities so please ignore snippets and sound bites you’ll pick up. We only use institutional and professionally offered bonds, not the high-charging variants offered by direct sales teams, so the cost is usually nil to 0.2% pa with no set up fee.
This applies to onshore bonds only – offered by UK-registered life companies like Aviva, Prudential, Transact and even HSBC Life. Effectively it works much like an ISA in that the income is not charged to the investor as it occurs – money in the bank deposit account generates interest that is taxed on you each year. Profit (known as policy gain) is only taxable on the investor when the money is withdrawn.
The onshore bond provider has to pay life company tax on the gains of your bond, and this is deemed equivalent to 20% basic rate. A higher rate taxpayer then has to pay the differential between the basic rate and the higher, or additional rate (think 40% less 20% basic rate = 20% still to pay).
Let’s look at a gain of £100 – the life co will pay 20% and pay out to the investor the £80 that’s left. The 40% taxpayer then has to pay a further 20% to bring the total tax paid up to 40%, just as with bank deposit interest.
The trick is the £80 is not grossed up.
What happens is the 40% taxpayer has to pay a further 20% on the sum received – so £80 x a further 20% is £16, meaning the 40% taxpayer is only paying 36% income tax.
Similarly, a 45% taxpayer has to pay a further 25% on the £80 received, being £80 x 25% = £20, leaving the income tax at an 11.1% discount. Permanently. This is not a ‘scheme or wheeze’, this is simply the (very) long-standing taxation of life insurance policies.
So now we have the wrapper and we have the tax benefit – and we also have the cash rates. Transact, one of our preferred bond providers, pays 4.48% on instant access cash held anywhere on its platform. This cash is spread across seven mainstream banks – that’s important to us, we remember 2007/08 when people deposited their money with banks whose names they could neither pronounce nor spell.
This is not a deposit account and should not be used as such. We do not levy our % charges on cash holdings but we are likely to charge a flat execution fee depending on if the investor is an existing client or not. Transact charge 0.26% pa for £500k, so the net sum to the investor now would be 4.22%. To a 40% taxpayer that is the same as 4.50% at the bank, and for a 45% taxpayer it is 4.60%. When used for long-term income generation, combined with a portfolio of reliable income assets, it’s a very effective product.
/6. Henderson International Income – what to do if you hold it.
If you’re a client you’ll already have received an email from Jim Harrison outlining what’s happening and what to do. If you hold this trust and you’re not a client then we recommend you seek advice as it’s shortly to disappear.
/7. Long-term income versus RPI – the data.
We have to deal with inflation.
We track our income data from 1986 alongside RPI – not the lower CPI – and run rolling comparisons. Remember inflation is always backward looking, it can only ever tell us what happened in the past. For us, we are trying to figure out how to match future income increases against future inflation, we are trying to skate to where the puck is going to be, as taught by the great Wayne Gretzky:
This table shows the average dividend increase across our research pool of 31 trusts, measured on a 5-year rolling basis. RPI is measured the same way, and the data in the table tells its own story:
/8. What did you do last Tuesday?
The date was the 25th of February, sunrise was at 6.53, sunset was at 5.34 in the afternoon. It didn’t rain in London, the media and websites were telling tales of Trump and the ongoing war in Ukraine, Woman’s Hour was at 10 on Radio 4 and Crystal Palace beat Aston Villa 4-1. For many of you reading this, this was the reality of retirement: life goes on, rain showers and sunny in places, slightly chilly at 8 degrees and no grand parties, tournaments, concerts or shows. Roll back a few years ago and you’d have been on the 7.04 from Guildford, you’ll have had January’s financial results in, client work to review and staff matters to deal with.
Retiring well is not about the money, it’s about the life in retirement once you have had the core routine that your entire adult life has been based on, removed entirely. Make you have a structure and routine to replace the employment framework. Here are some ideas for March:
I know some readers here have a penchant for loud music: https://www.cartandhorses.london/news-offers-events/441679-the-ides-of-march-maiden-tribute/
The Kew Orchid Festival is on today and tomorrow: https://londoncheapo.com/events/orchid-festival/
Cologne’s Festival is on in the first week of March.
Il Trovatore, by Verdi, is playing at the Royal Opera House.
Nureyev’s Sleeping Beauty is on at the Opera Bastille in Paris.
Whitstable’s Fisherman Huts are available to rent, eat fresh oysters at the Oyster Co.
New Orleans Mardi Gras – Fat Tuesday is next week.
If not now, then when?
