‘Can we fund care and leave a hefty inheritance?’

Will and Ann are 62 and 64, respectively. He receives about £40,000 and she receives about £20,000 a year from index-linked public sector pensions. These pensions have dependent partner benefits so, although they are not married, when one of them dies the surviving partner is entitled to half the payout of the other's pensions. They both expect to receive the full state pension from age 66.

Will also makes about £4,000 and Ann makes about £2,000 a year by providing boat and sewing services. They use the money to buy voluntary National Insurance contributions to increase the value of their state pensions.

They have two financially independent, adult children. Their home is worth about £400,000 and mortgage-free.

“Our pensions are more than sufficient to meet our financial needs so, other than a probable need for care in later life, we don't expect to have to draw from other assets,” says Will. “We also have self-invested personal pensions (Sipps) that are invested to grow while preserving their value, and we will use these to cover any unexpected events. My Sipp is worth about £337,000 and takes the value of my pensions close to my protected lifetime allowance of £1.25mn. Ann’s Sipp is worth about £169,000 and she still contributes £3,600, including tax relief, a year to it.

“So our core objective is to build up assets within trusts for our children and future generations. We are keen to financially support, but not indulge them. We have set up two discretionary trusts of which Ann and I are the settlors and trustees, and our children and their descendants are beneficiaries. We aim to eventually put assets worth around £4mn in trust.

“So far, we have transferred assets worth approximately £1mn into the trusts. We are running down our investments in venture capital trusts (VCTs) and individual savings accounts (Isas) to the value of our inheritance tax (IHT) allowances, by transferring capital and surplus income into the trusts. Our Sipps’ expressions of wishes and our wills leave everything except our home to new trusts.

“We aim to reduce the value of our IHT-liable estate to below £1mn, which we have almost done, but our investments are making too much money.

“One trust has just over £400,000 in it made up of gifts out of surplus income, so no IHT liability. Each year we gift dividends and income worth about £60,000, which are surplus to our income requirements, to this trust. The other trust comprises gifts worth £300,000 from each of us. Ann's IHT liability is covered by a £120,000 term life policy written into trust, which expires seven years after she made the gift, and half of my gift is invested in IHT-exempt Aim shares. The other half of my gift is the proceeds of the sale of a property and IHT-liable for about another four years.

“The trusts have lent £800,000 to our children, which they have invested in their Isas and Sipps.

“We have saved for nearly 40 years and actively invested for about 20. I enjoy the intellectual challenge of investing but the rest of the family doesn't, so I want to create a portfolio that needs minimal supervision when new trustees take it on. Given the timescales, tax planning is also an important consideration. The portfolio, including our pension income, is largely exempt from income and capital gains tax liabilities, and we aim for it to eventually be IHT-free too.

“We would like the investments to make an average annual return of around 8 per cent over the long term and, so far, their returns have exceeded this. Over the past 20 years, our portfolio has only lost money over the course of a financial year twice – about 10 per cent in 2008 and 5 per cent in 2020. On both occasions, its value soon recovered.

“I have developed a probability/consequence model, which aims to minimise investment risk. I run the portfolio, in effect, like a hedge fund. It has a position in a long/short contract for difference (CFD) to hedge it, which is proving profitable. I trade sporadically to maintain the portfolio’s asset allocation.

“I mainly invest in investment trusts focused on different types of assets with a variety of risk profiles, and venture capital trusts (VCTs) to mitigate income tax. I plan to invest more in VCTs. We also hold direct shareholdings to boost the income and/or as IHT-exempt investments.”

NONE OF THE COMMENTARY BELOW SHOULD BE REGARDED AS ADVICE. IT IS GENERAL INFORMATION BASED ON A SNAPSHOT OF THESE INVESTORS' CIRCUMSTANCES.

Saisha Moyce, private client manager at Brooks Macdonald (BRK), says:

Although your current sources of income meet your needs, cash flow planning would help to forecast different scenarios, including the potential need to fund care in future.

You want to cover your financial needs during your lifetime, and to provide for your children and grandchildren. But also think about how the surviving partner will be able to cover their expenditure after one of you dies. If Will dies before Ann, two-thirds of previous pension income will be available, and five-sixths of it if she dies before him. Consider this when balancing meeting expenditure throughout your lives and gifting.

Your home could be used to cover an income shortfall if necessary. But you would need to consider how attached you are to your home and the liquidity of the property market at the time you sell, as you might not be able to sell within your desired timeframe or get an acceptable price.

As you are unmarried, you can't inherit assets from each other IHT-free. So IHT may be payable on the first of your deaths if the value of the assets exceeds the nil-rate band. You also can't transfer any unused nil-rate or residence nil-rate band to the surviving partner. So ensure that both your wills are up to date because the rules of intestacy are unlikely to give you the outcome that you want.

Also review the ownership structure of your home. Joint tenancy means that ownership of the main home is automatically passed to the other owner when one of you passes away, and would incur IHT if the nil-rate band is exceeded. If you hold your home as tenants in common, your share of the property could be distributed to a direct descendant and potentially benefit from the residence nil-rate band exemption. You cannot transfer unused nil-rate band or residence nil-rate band to the surviving partner, so use it or lose it. If you leave a share of the property to your children after the first of your deaths it may have unintended consequences, for example if your children had a share of the house and then divorced. This element of planning is less complex if you are married or in a civil partnership.

You want to protect but not indulge future generations, so take great care with the selection of future trustees. Who will be able to strike this balance beyond your lifetimes? You may have family friends who could do this or may need to employ a professional, such as a solicitor.

Keep good and clear records of the gifts out of surplus income to make it as easy as possible for your executors to provide evidence of this to HM Revenue & Customs. Also be aware of the 14-year rule. There was no immediate charge to IHT on the transfer of the gift to the trust as the chargeable lifetime transfer was beneath your nil-rate bands. However, the 14-year rule applies where there are chargeable lifetime transfers in the seven years before a potentially exempt transfer has failed because you passed away within seven years of making it.

You have to hold shares that qualify for Business Relief for two years before they are IHT-exempt. VCTs are not exempt from IHT but enterprise investment schemes (EIS) are, as well as offering other tax reliefs. But also consider the higher risk profiles of such products and that VCTs provide tax-free dividend income.

Ann's pension contributions will help to build up IHT-exempt assets, but she can only get tax relief on these up to age 75.

As Will aims for the value of the Sipps to grow so that they can provide for unexpected events, this objective might be more important than mitigating the lifetime allowance charge at age 75. 

Joseph McGarvey, wealth planner, at Brown Shipley, says:

It's encouraging to see how comprehensive your retirement strategy is. Index-linked pensions provide a solid foundation and protection against the effects of inflation. These will be supplemented by state pensions, which could provide an additional joint income of approximately £19,000 before tax a year. You can get forecasts of your state pension entitlements at https://www.gov.uk/check-state-pension.

Your Sipps are outside your estates for IHT purposes, an important advantage on top of the tax-free growth of the investments within them. Because of this, pensions should usually be the last asset you access when you need capital. 

Later-life care can be a huge financial burden. The average cost in the UK for a nursing home is £888 per week, or £46,176 a year. A cash flow plan would help to map different scenarios and stress-test affordability, and might highlight a need to retain more of your wealth instead of making further gifts into your family trusts. 

VCTs were introduced to encourage investment in early-stage businesses. They are high-risk investments, but have advantageous tax benefits such as tax-free dividends and 30 per cent upfront income tax relief. And you can invest up to £200,000 per tax year into them. But VCTs are typically suitable for high-income individuals who mainly invest in them for the tax benefits. So as you are cautious about losing capital, which doesn't suit a high-risk investment strategy, it would be helpful to understand your rationale for continuing to invest in VCTs. If you have available capital to invest, consider if it might be better to first invest it within tax-efficient Isas, into which you can put up to £20,000 each tax year.

Consider taking advice on your likely IHT liability, which includes your personally owned assets but not your pension funds. VCTs and Isas are subject to IHT. If you want to mitigate IHT with your existing investments, consider business relief assets, which are IHT-free after you have owned them for two years, some of which you can hold within Isas. But these types of investments can be high risk.

Do you have up-to-date wills and powers of attorney? Without a will, assets may pass to unintended recipients on death – especially as you are not married and won't benefit from the IHT exemption for spouses, which enables them to pass assets to each other on death without incurring this tax.

Appoint trustees to the trusts who understand the responsibilities of the role, including the requirements of trust registration introduced last year. Engaging a professional trustee may be helpful.