We are reviewing the advice given in relation to cumulation:
I’ll give you a few options but be careful of one point, cumulation – I’ll explain (beware though, by my own admission this is quite a technical answer that you will have to read a few times but the tip is a good one): If you make a gift it will take 7 years to be removed from your estate and there is a sliding scale on the tax during the 7 years. Cumulation occurs when another gift is made before the 7 years has passed.
Example: a chargeable lifetime transfer is made in July 1995 of £100,000. In June 2002 another is made (i.e. one month away from 7 years). The individual dies in December 2004 leaving an estate of £200,000.
At first we may think this is less than the nil rate band of £263,000 (at the time) and there will be no tax to pay – you guessed it… that’s not the case. To calculate liability we need to look at what transfers have been made in the 7 years prior to death. We also have to take into account cumulation at the time the potentially exempt transfer (PET) was made. Cumulation brings into play transfers that were made in the 7 years prior to the PET being made. This catches the gift made in 1995 and this £100,000 is taken off the nil rate band at the time of death of £263,000.We now have a nil rate band of £163000. They now assess the PET of £200,000 and the £37000 not covered by the nil rate band is taxed at 40%. The death calculation is now assessed. The estate is valued at £200,000 on death. The £200,000 PET made reduces the nil rate band of £263000 and the nil rate band is now £63,000.
As the estate is now £200,000, £137000 is not covered by the nil rate band and is taxed at 40%. The final bill is £69,600. To avoid the tax a few changes could have been made: If the second gift had have been delayed until the end of the first 7 year period there would have been a £14800 tax saving.
As to the remaining tax: Instead of making a gift of the £200,000 the £200k could have been put into a purchase life annuity. The purchase life annuity provides a very tax efficient income as most of the income is deemed as return of capital. On day one this capital has disappeared from the estate and avoids the seven-year wait. As the income is so high from the annuity a proportion of this could be used to then set up a life policy in trust for the beneficiaries. As it is in trust it would not form part of the estate and would be moved around to the beneficiaries tax-free.
The result as a difference from the above scenario is that the £14800 tax would have been saved, as would the second £54800 and the person making the gift would have enjoyed a healthy income in between – cake and eat it scenario. There is also the option of a trust that allows for a gift to be made into a trust of the £200k which is set up at the outset with an ‘income’ payable to the person making the gift. A calculation is made at the outset and the initial gift is discounted by the right to the capital coming back.
Our advice on the above:
Excellent. Remember to consider the laws relating to gifts into trusts.
Worldwide’s score: 10 out of 10
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