Long Term Care: Choosing the right IHT plan

Colin Godfrey looks at the different inheritance tax mitigation strategies available to those looking to fund long-term care.

Until recently, most people who were looking to manage their investments after retirement were looking mainly at inheritance tax (IHT) planning. Now many worry about their ability to fund decent residential care, should they need it.

The average cost of care is now about £26,000 per year, but for a high-quality home in the south east, the costs can be close to £50,000 per year.

According to Partnership, there are about 10,000 people aged over 100 in the UK and the average length of stay in a care home in England is estimated to be about 2.5 years. But most self-funders live on average for four years and 12% live for eight years or more.

This leaves an obvious dilemma for IHT planning as a prudent individual may be looking at setting aside well in excess of £200,000 to fund care that they may never need and, in so doing, handing HMRC a cheque for £80,000.

This article examines some of the product-based solutions available for IHT planning, with a particular focus on those that may also be suitable as a long-term care (LTC) depository. In 2007-08, before the economic downturn, IHT revenue to HMRC peaked at more than £3.8bn - 60% of which related to taxable assets between £100,000 and £500,000.

According to data for that year, 50% of the assets on which tax was paid could be described as liquid (being cash or securities), which would indicate that many people retain a substantial financial buffer in their old age.

In 2010-11, IHT was more than £2.7bn, providing a similar level of revenue as the duty on wine (£3.1bn) and beer (£3.2bn). However, perhaps half of this tax is paid needlessly due to a lack of appropriate planning.

The value of our earnings and assets has grown over the years (for many, the value of our homes alone can exceed the minimum IHT threshold), but the IHT threshold has not kept pace, with the result that more people are being caught in the IHT trap.

Upon death, the assets of a UK-domiciled individual collectively worth more than £325,000 will be taxed at 40 (£650,000 for couples). Assets caught may include those held in trust, gifts, the family home, other property holdings (UK and overseas), contents, payouts from insurance and other policies, business assets, lump sum pensions payments, cash, stocks, shares and other holdings including jewellery.

This article focuses on product strategies for general IHT planning. For larger or more complex estates, specialist advisers are likely to employ a mix of trust planning and inheritance-friendly products.

There is no panacea to IHT or care planning, but the starting point is that everyone with assets must make a will.

Choosing the right strategy

Assuming that the option(s) chosen are affordable, the first consideration is risk. Our tolerance to risk should reduce as we move towards and enter retirement.

Next is the attitude to ownership and liquidity. Are we prepared to give away money for good, or might we possibly need it again to fund long-term care? And do the IHT solutions need to provide income?

So long as interest can be serviced, it is possible to take out a loan against the home and invest this into a suitable IHT product. This allows the element of the property subject to the loan to be free from IHT, and prevents otherwise having to sell the property in order to mitigate IHT.

Gifts and potentially exempt transfers are a simple way of passing wealth on free of IHT, but the donor cannot retain any form of ownership and the seven year rule applies (subject to taper relief).

Unless a trust is used, large gifts to adult children might be caught up in divorce settlements. A term assurance policy can cover IHT on gifts in the event that the donor does not survive seven years, but in later life the premium can be prohibitive.

All these options involve losing ownership of wealth and, for this reason, should only be pursued if one is certain that the money will not be required again in later life.

Agricultural property is generally the preserve of the wealthy seeking capital protection. Land prices have risen strongly in recent years, so income returns tend to be low.

Acquiring a working farm can be a lifestyle choice, but there is often strong demand for quality examples. Forestry schemes offer a niche option - usually without income.

Renewable forestry ticks the environmental box, but wood is a commodity and prices can quickly fluctuate.

A question of trusts

Trusts can be highly complex and require expert advice since there are many options, including bespoke ones, and legislation has targeted this area in recent years.

Loan trusts allow the original investment ownership to be retained, while the beneficiary receives capital growth IHT free.

Normally, the donor relinquishes ownership, although some trusts do allow a change of beneficiary and discounted gift trusts allow the donor to receive income.

Alternative investment market shares allow retention of ownership, but few regularly pay income dividends, so most people invest for capital growth.

The FSA believes they are classed as high risk as the value of many AIM shares has fallen considerably in recent years. They can suffer from market volatility and speculative activity.

Low trading volumes mean that some stocks may not be liquid (readily sold) and shares commonly trade at substantial discounts to net asset value. Business Property Relief (BPR) is less well-known, but has long benefited families who, on death, have passed their business from one generation to another free from IHT. It provides 100% relief after only two years.

Indirect products, often referred to as wealth preservation funds, allow investors to enjoy the benefits of BPR without having to own and run a trading business.

The businesses often own and operate from quality properties and usually provide an element of in-built diversification through the different types of businesses and locations from which they operate.

The more flexible products offer an optional income return and allow return of all or part of the investment before death (although that part redeemed is then subject to IHT).

Most advisers will opt for a cocktail approach, combining at least two solutions.

The bigger challenge can be convincing the client that IHT planning is better thought about sooner rather than later. This is because IHT can have a devastating effect on the families of those who are unprepared.

Colin Godfrey is director of Tritax