INHERITANCE TAX is a tax incurred by a proportion of estates of those who have died and surpassed the Nill Rate Band amount. But what are Rysaffe arrangements and could they save you money?
Inheritance Tax (IHT) may be subject to radical change in the coming months as the country attempts to regain its financial foothold in the wake of the extremely costly global coronavirus pandemic. IHT is paid from funds within the estate or from money made from the sale of assets, but in some cases one can drastically cut down the level of tax. So what exactly are Rysaffe arrangements?
What is Inheritance Tax?
IHT is a tax on the estate, including the property, money and possessions, of someone who has died.
The amount one pays depends upon the full value of the estate which is based on the total asset value including:
- Cash in the bank
- Payouts from life insurance policies
- (Minus any debts and liabilities).
How much IHT do you pay?
For many people, IHT can be avoided entirely if the value of their estate is below the Nill Rate Band of £325,000.
You can also avoid paying tax by leaving everything which is more than the £325,000 threshold to a spouse, civil partner, a charity or community amateur sports club.
Your estate will owe tax at 40 percent on anything above the £325,000 threshold when you die, or 36 percent if you leave at least 10 percent to a charity in your will, excluding the main residence allowance.
How does gifting work in regards to IHT?
You can greatly reduce the level of IHT on your estate by making a gift to your family and friends while you are alive.
However, you must plan this as you can inadvertently fall into a pitfall when making a gift and incur more tax.
A surviving spouse can inherit an entire estate without paying any IHT, but gifts to an unmarried partner might incur Inheritance Tax.
You can give your children or family a gift tax-free.
As long as you live more than seven years from when you make this gift, the recipient will pay no IHT on your gift when you die.
However, any income made from this gift could have tax implications for the beneficiary, for example, Capital Gains Tax.
If you do not live for at least seven years after making this gift, it will become a Chargeable Transfer which means it will become subject taxation.
What are Rysaffe arrangements?
Inheritance Tax can cost your loved ones hundreds of thousands when you die, but there are many legal routes to avoid paying extensively.
For very large investments, it is possible to reduce or eliminate periodic charges by creating more than one trust on different days using the Rysaffe principle.
The Rysaffe principle is a way of using multiple trusts to reduce the IHT payable as each trust has its own nil rate band.
The Rysaffe principle relates to Rysaffe Trustee Co (CI) v Inland Revenue Commissioners (2003) where a series of trusts were created on consecutive days.
Essentially the principle means by establishing a series of smaller trusts, rather than just one, you can reduce the impact of the 10-yearly periodic charge and exit charge by benefiting from a nil rate band for each individual trust.
The benefit of doing this reduces the payable IHT amount.
For example, in scenario one £500,000 is invested into one bond under a discretionary trust and no previous chargeable lifetime transfers.
Initial charge (Entry tax):
- If the £500,000 is invested into one bond under a single trust, there will be a chargeable lifetime transfer (CLT) in respect of the amount above their available NRB. We will assume the full NRB is available.
- Value of transfer into the discretionary trust: £500,000
- Less settlor’s available NRB: £325,000
- Excess: £175,000
- Tax at lifetime rate of 20% on the excess over the NRB: £35,000 entry charge
First 10- year review (periodic charge):
- The value of the trust fund at the 10-year Periodic Charge is £790,000.
- Trust fund value: £790,000
- Less current available NRB: £350,000 (assume increased to £350,000)
- Excess: £440,000
- Tax on excess at lifetime rate: (£440,00020 percent) £88,000
- Tax as a percentage of ‘chargeable value’: (£88,000/£790,000) 11.14 percent
- 3/10 of the effective rate: (11.143/10) 3.34 percent
- Tax on trust fund: (£790,000 * 3.34 percent) £26,386 periodic charge
But if the Rysaffe principle is used and the £500,000 is invested into four separate bonds, each with a premium of £125,000 and write each policy subject to different discretionary trusts on different days, there will still be an initial charge as only the settlor’s available NRB is assessed on the initial transfer into the trust (CLT) the following happens.
The total tax on 10-year periodic charge could be £17,696 some £8,690 less than the first scenario where one trust is used.
Friends Provident calculates that if £500,000 was invested in five different loan trusts, rather than one single one, then there would be no periodic charge in the first 40 years, saving the trustees a total of £101,172.
This would be conditional on the trusts not being treated as ‘related settlements’, which they should not be following the Rysaffe case.