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But, could you have your cake and eat it? - news article image

But, could you have your cake and eat it?

16 Mar 2021

4 minute read

The Oxford Dictionary of Proverbs provides evidence that this popular quotation, that you cannot retain your cake for future consumption having already eaten it, dates back prior to 1546, when it was included in a compendium compiled by John Heywood. 

In my financial world it is often used in the context of Inheritance Tax (IHT) planning because HMRC will not allow continued use of assets that have been given away – this breaks the rule commonly known as the “reservation of benefit rule”. 

The classic textbook explanation being that you cannot give away your Van Gogh whilst still hanging it on your own wall for your enjoyment – HMRC see through this and still include it’s value in your estate for IHT purposes.

This provides a huge dilemma for many families that would like to gift assets to improve their IHT position but also have a huge concern about needing money to cover future expenditure needs such as Long Term Care, which as we know can be hugely expensive.

However, with careful planning this dilemma could be overcome by using what is known as a Flexible Reversionary Trust – which is an arrangement that has been around for some time, and therefore has a track record of effectiveness but is under-used in my opinion. 

Like all trust and gift based solutions, for IHT purposes it requires 7 years to work and therefore is more likely to be effective if aged under 80 when you set it up; it allows a married couple to shelter up to £650,000 from IHT without an immediate IHT charge when setting up the trust.

The “can’t have your cake & eat it” analogy is broken to some extent, because the creator (settlor) of the trust is allowed to retain access to a proportion of the trust money each year.

So let’s delve a little deeper into how this arrangement works:

The trust is essentially cut up into numerous parcels of equal value, which could be 10, 15, or 20 for example – on each Trust anniversary one parcel can be paid to the settlor as a maturity encashment providing cash for living expenditure. However, if the money is not needed then the parcel maturing can be deferred until a later date.

If the parcel maturities are taken out then the money comes back into your estate, whereas if the parcels are deferred then the value remains in the trust. During the first 7 years the value of the original capital placed into trust is deemed to be part of your estate, but after that the whole value of the trust is outside your estate.

With careful planning and scheduling of the maturities a regular annual access to capital can be arranged, which can be taken if needed, whilst also keeping the remaining trust assets outside of your estate for the rest of your life.

It is worth mentioning that the parcels are sub-divided into mini-parcels – which means that when maturities occur you have the flexibility to take as much of the parcel value as you need, deferring the rest for a date in the future.

For any family that wants to arrange their affairs IHT efficiently but has a real fear that they might not be able to cover the costs of care in later life then this might well be close to the perfect answer. Particularly useful if, like many, you would prefer to receive care in your own home and are therefore unable to sell your house to pay for care.

I would suggest that anyone considering one of these arrangements should think about appointing a professional trustee to protect their interests and definitely set up Lasting Powers of Attorney so that you have someone acting on your behalf in the annual maturity/deferral process should capacity be lost.

And there you have it – you can have your cake and eat it, albeit with some caveats, but that’s tax for you!

As you might expect there are complexities that need to be understood which are beyond the scope of this short article – but Shaw Gibbs Financial Planning and Personal Tax Departments are perfectly placed to guide you through these if you think this might be appropriate for you.

But, could you have your cake and eat it? - news article image


Tim Davison

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