Joan is divorced and has been reading about the potential costs her beneficiaries will have to deal with when she dies. She is worried that, as the government is planning to introduce a tiered fee system for obtaining probate in the UK, her current estate could incur the maximum fees of up to £6,000.
If this is added to the average funeral cost of £4,271, it could mean her two children, who are the sole beneficiaries of her estate, have to deal with substantial costs at an already difficult time. Having gone through the process herself, as her parents passed away when she was young, she is keen for her children not to be burdened with these costs.
Joan owns her own house, which is valued at £500,000. She sold her successful recruitment consultancy business four years ago for £1.5 million, and has savings of more than £200,000.
She is keen to mitigate tax where she can, but is also mindful that she wants to enjoy her retirement so does not want to give her assets away.
First, Joan could look to take out a whole-of-life policy, which will cover any probate fees, the cost of her funeral and any inheritance tax (IHT). It is worth noting some policies will help people meet the cost of funerals by advancing payment of the sum assured up to £10,000.
However, to avoid the payout from the policy becoming part of her estate and pushing the probate fees up, she could place the policy in a trust and name her children as beneficiaries. The two types of trusts Joan could write the policy into are a bare trust or a discretionary trust.
A bare trust is less flexible than a discretionary trust, and is therefore not suitable if the policy includes any critical illness cover, which would pay a benefit to the settlor if a claim was made while they were alive.
A discretionary trust would offer Joan greater flexibility to change or add beneficiaries, meaning, if she eventually had any grandchildren, she could also make provisions for them
However, she should be mindful that gifts made into a discretionary trust will be regarded as chargeable lifetime transfers, and are potentially liable to an immediate IHT charge at the lifetime rate of 20%.
If she does not want to go down the trust route, she could also gift some of her money outright by using her gifting exemption of £3,000 a year. However, if she wanted to gift a larger sum, it would be classed as a potentially exempt transfer. This means she could be liable to IHT unless she lives for seven years past the point of gifting.
This method would gradually reduce the size of her estate and subsequently reduce how much the probate fees would amount to under the tiered system, assuming the proposals to introduce the new rules are accepted by parliament.
The final planning technique Joan could consider, which would help mitigate IHT, is putting some or all of the proceeds from the sale of her business into a loan trust. No gift is made (and she will have access to the full amount of the loan as that remains in her estate) but any growth on the loan will be outside her estate for IHT purposes.
Rachael Griffin is tax and financial planning expert at Quilter