If the two sure things in this life are death
and taxes then Inheritance Tax is impossible to avoid. Or is it?
To find out, I consulted expert Brian Shirreff, of Thackray Williams
solicitors.
Getting advice
'Estate planning is a complex area, and so the first fundamental
is that anyone wanting advice about it should see a specialist.
'The second fundamental is to plan early. Some estate planning arrangements involve
making gifts and surviving seven years. The government may change the seven-year
rule into for example, a ten-year rule, so it is essential to obtain early advice.'
How to approach it
'In the case of married couples or civil partners, often the first step is to
see if tax-planning wills will eliminate inheritance tax (IHT). If they have
a joint estate not exceeding £570k (twice the tax-free allowance or Nil
Rate Band (NRB), as it is called) they will not need to look at any other form
of estate planning. This is because properly drawn wills can ensure that IHT
is paid neither on the first nor on the second death.'
Tax Planning in Wills
'Remember two things: 1) gifts from one spouse or civil partner to another are
exempt, and the exemption is unlimited; and 2) everyone is entitled to the NRB
of £285,000.'
'Take a married couple who are each worth £285,000 and have children. If
husband H dies first and in his will gives wife W his entire estate there will
be no IHT on his death. W is exempt, remember. But if W later dies worth £570,000,
her NRB of £285,000 gets deducted and the remaining £285,000 gets
taxed at 40%. So the tax bill is £114,000. What has happened is that H's
estate has got bunched with hers, because he has failed to use his NRB correctly.
What can H do to avoid this bunching effect?
'One solution - in the above example - is for H to give his estate to the children.
That would be free of tax as it is within his NRB. If W dies worth £285,000
she can leave that to the children free of tax, as that too is within her tax
allowance.'
'That solution will work for IHT purposes, but there could be problems. One problem
is that W may want the assets herself for general financial security or for nursing
home fees. Whilst most children will be happy to look after their widowed mother,
what happens if one of them dies, divorces, goes bankrupt, is married to a domineering
person or just gets awkward? The risks are significant. Such risks in one's later
years are undesirable and most will want a better solution.'
A better solution - the discretionary trust
'There is a better solution. Instead of leaving the value of the NRB to the children,
leave it to a Discretionary Trust. So in your will you give a legacy to the trust
of "the maximum sum I can give without paying inheritance tax", not a fixed sum
because the allowance goes up each year in the Chancellor's Budget. It must be
a Discretionary Trust, because that is the only type of trust that is not taxable
when a beneficiary dies. The trust is a "will trust", and does not take effect
until the testator dies; it is triggered on the first death.'
Trustees
'The will names the trustees. They can be the same people as the executors, whose
job it is to administer the estate. The surviving spouse can be one of the trustees.
For technical tax-planning reasons there should be at least two trustees. Four
is the maximum. If you appoint an adult child as joint trustee you are creating
a potential conflict between the interests of the surviving spouse (who will
need access to the trust assets during his or her lifetime) and the interests
of the children who would like to benefit from the trust sooner rather than later.
A dominant son-in-law or daughter-in-law might be a problem. The best is to appoint
a professional to act jointly with the surviving spouse. Whatever the decision,
it is vital that when the first spouse dies legal advice is taken to set up the
trust correctly.'
Beneficiaries
'The will names the beneficiaries of the trust. They beneficiaries will be in
a "pool", none of whom will have any entitlement to income or capital. The pool
will usually include the surviving spouse, the children, grandchildren and also "default" beneficiaries
just in case close family die out. The trustees can exercise their discretion
in favour of whichever beneficiary or beneficiaries they choose but are often
guided by a Statement of Wishes signed by the testator.'
Managing the trust
'Managing a trust can be time consuming and costly. The trustees will take possession
of the trust assets. On the first death the assets available may be half the
house or investments or a combination of the two. Trust income goes into a separate
trust bank account. Trustees make annual tax returns, prepare annual accounts
and meet from time to time. You will not want the cost or inconvenience of doing
that. Is there another way?'
Another way - the debt scheme
'Instead of transferring assets to the trustees who manage the trust, the trustees
can lend the entire value of the trust fund to the surviving spouse. If they
decide to do that all the assets are transferred to him or her in return for
an IOU promising to pay £285,000 (or whatever is the NRB) to the trustees.
The surviving spouse will then have the entire joint estate under his or control.
The trustees will hold an IOU which in practice is repaid on his or her death.
The IOU is a liability of the estate and deducted for IHT purposes. On death
the trust money can be distributed to the next generation. This is known as the
Debt Scheme. Former deputy head of the Capital Taxes Office, Mr Peter Twiddy,
was once asked what the Revenue's attitude was to the scheme. His reply: "If
you do it right, it works".'
Joint property
'The way in which you own joint property can be important for estate planning
purposes. You can own property jointly in two ways, either as "joint tenants" or
as "tenants in common". These expressions (which have nothing to do with landlords
and tenants) apply to any type of asset, including freehold or leasehold properties,
bank or building society accounts, shares, a car or household furniture - anything,
in fact.'
Joint tenants
'Ownership as joint tenants means that on the death of one of the owners, the
property passes to the surviving owner (or owners, if there are more than two).
No share of the property passes into the deceased owner's estate, but passes
outside the estate direct to the survivor(s). You cannot give anything away as
a joint tenant. However the Revenue will still treat a share of the property
(usually one half) as being part of a deceased person's estate for IHT purposes.'
Tenants in common
'If you own as tenants in common, you own a specific share which forms part of
your estate and which you can therefore give away in your Will. A tenancy in
common is usually advisable for tax planning in your Will. If you have created
a Discretionary Trust in your Will along the lines described earlier it may be
that the gift of the NRB cannot be satisfied on your death without using part
or all your share of the home. So if the home is owned as joint tenants no part
of it is available to be put into the Trust and the tax planning cannot be fully
carried out. Thus the home should be held as tenants in common. You can convert
from one method to the other at any time by signing a suitable document.'
By Sarah Modlock.
Source: Yahoo Biz.
