This is the fifth in a series of posts based on a webinar delivered by Infinity. Using case studies, the webinar looked at how trusts can be utilised to reduce inheritance tax (IHT) liability in the UK.
This time we take the example of a British husband and his non-UK domiciled spouse, Farah, who is Malaysian. The fictional case study shows how setting up a trust in conjunction with a QNUPS reduced their IHT liability from £140,000 to zero.
Reducing inheritance tax using an excluded property trust: a case study of a British/Malaysian couple
- John, 55, is a British expat working for Petronas. He has been working internationally for 15 years and is now settled in Malaysia.
- John is married to Farah, who is 48 and Malaysian. They have two children.
- John intends to retire at 60 but the couple are unsure where they will live when he does, possibly the UK.
- An IHT liability of £140,000 upon John’s death.
Below left is a summary of John and Farah’s assets and below right their IHT liability as things stand:
Points to note:
- NRB is the Nil Rate Band, the amount of the estate exempt from IHT when John dies (£325,000)
- Farah is non-UK domiciled so also benefits from the spousal exemption (£325,000)
In addition to the hefty IHT bill, a major problem with this scenario is that if John dies, Farah will have insufficient cash reserves to pay the IHT due on the state. With £140,000 of IHT owing and just £75,000 in cash holdings, Farah is £65,000 short. IHT must be paid prior to probate being granted so she cannot sell the assets within the estate to pay IHT. A bridging loan or similar would need to be sought to bridge the gap.
The solution: An excluded property trust and a QNUPS
- John gifts investments to Farah and she invests them into an excluded property trust via an offshore bond
- Farah and John are the trustees along with her brother, Daniel
- As a trustee, John retains some control over the assets
- The beneficiaries of the trust are John, Farah and their children
- Farah is the settlor as well as a trustee and beneficiary, John is a trustee and beneficiary (this blog post explains these terms)
- The gift from John to Farah is classed as a Potentially Exempt Transfer (PET) and subject to the seven year rule i.e. after seven years, it will be outside John’s estate
The table below shows how their assets break down once the trust has been set up. The total value of the estate is £1,000,000.
After seven years, John retires and the couple move back to the UK. Prior to repatriation, John sells his German investment property for €690,000 (£575,000), increasing his cash holding, and the value of the excluded property trust has also increased. The value of his estate has now risen from £1million to £1,545,000 which breaks down as follows:
Shortly after repatriation John dies. It has been over seven years since he established the excluded property trust so the value of this falls outside his estate. The IHT due on his estate is calculated at £90,000 as per the following breakdown:
While the value of the estate has increased, the IHT due has been reduced by £50,000 from £140,000 to £90,000. In addition, the cash reserves more than cover the IHT due.
Reducing IHT liability with a QNUPS
However, adding a QNUPS into the equation can bring the IHT liability down to zero. Here’s how:
John has no pension income so, prior to repatriating, he establishes a QNUPS using some of the property proceeds, his cash and investments. It is important to note that the QNUPS must be set up before he moves back to the UK. As it is classed as a pension, a QNUPS is exempt from IHT.
John plans to buy a home for £400,000 and keep £75,000 in cash as an emergency fund leaving £400,000 to fund a QNUPS to provide him and Farah with an income. Here’s how the QNUPS changes his IHT liability:
The £400,000 QNUPS has significantly reduced the value of the taxable estate bringing the IHT liability down to zero.
Take a look at this summary of the three different scenarios:
This case study shows how effective using trusts and other tax effective pension wrappers can be in minimising IHT liability. Obviously, your personal situation will not exactly mirror John and Farah’s, but the example gives you an indication of what can be achieved with careful estate planning.
If you are a British citizen with a foreign spouse, why not contact me at Jamie@infinitysolutions.com to discuss your estate planning and see what can be put in place to reduce your UK IHT liability?
Disclaimer: Please note that the information in this post is for information only. Trusts and inheritance tax planning are complex subjects with no one-size-fits-all solution. You should always seek expert advice from a qualified professional before making important financial decisions.
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