Inheritance Tax

Please see attached link for an article on inheritance tax planning via your Wills written prior to the pre-Budget statement made by the Chancellor on 9th October 2007.

Background

You will note that the article refers to the incorporation of either an outright gift to your ultimate beneficiaries or a gift to a nil-rate band discretionary trust which would come into effect on the death of the first to die.

Gifts of this kind have been increasingly included within Wills in recent years in order to ensure that the nil-rate band of the first spouse to die (i.e. the part of their estate which is free of tax regardless of the identity of the beneficiaries) was not wasted – as would otherwise have been the case prior to the 9th October 2007.

The proposed change

In the pre-Budget statement made by the Chancellor on the 9th October last it was announced that – with immediate effect – the unused nil-rate band of a deceased spouse or Civil Partner could be transferred to their surviving spouse or Civil Partner.

From the draft legislation it would seem that the amount of the survivor’s estate which is free from tax as a result of the nil rate band will be calculated by reference to both the percentage of the nil-rate band unused on the first death and the level of the nil-rate band at the second death.

For example, if the first to die uses 50% of their nil-rate band of, say, £300,000 and the nil-rate band has grown to £350,000 by the date of the second death then £525,000 of the survivor’s estate would be free of tax (1.5 x £350,000).

Using the same example, if the first to die did not use any part of their nil-rate band then £700,000 of the survivor’s estate would be free of tax (2 x £350,000), whilst if they used 75% of their nil-rate band then £437,500 of the survivor’s estate would be free of tax (1.25 x £350,000).


How does this affect you?

It is not necessarily the case that those who have incorporated either an outright gift or a gift into a discretionary trust should make changes to their Wills at the current time, it would seem sensible to review the provisions of the Wills at this time in light of the announcement in the pre-Budget statement. Indeed this perhaps highlights the importance of regularly reviewing your Wills in any event.

There would therefore now appear to be the following options available for those concerned to protect their ultimate beneficiaries’ inheritance against the impact of inheritance tax and/or against other risks via their Wills.

a) Leave everything to the survivor outright

In the current political climate you could be forgiven for assuming that the future growth in the value of the nil-rate band will exceed the likely growth in the value of property and investments. If this were to be the case then a greater inheritance tax saving could be made by taking this option than would be made by retaining the nil-rate band discretionary trust.

This option has the advantage of simplicity and would leave the survivor with total control over the assets in question. This ‘total control’ could, however, be a disadvantage if you have concerns regarding your ultimate beneficiaries’ inheritance of the assets in question, which could be at risk if the survivor were to fall out with them, re-marry, be made bankrupt or require long-term care.

In addition it will be necessary for the survivor’s executors to make a claim evidencing the entitlement to the nil-rate band of the predeceased spouse, following the death of the survivor. It is therefore extremely important that clear records are retained relating to the estate of the first to die. Further details of the requirements in this respect are awaited.

b) Incorporate a nil-rate band discretionary trust

If there are concerns regarding the effect which the re-marriage, bankruptcy, entry into long-term care etc of the survivor could have on the inheritance of your ultimate beneficiaries, then you might wish to consider incorporating a trust of this kind as it offers protection against these eventualities.

There could also be an advantage to the trust continuing beyond the survivor’s death if it would be inappropriate for any of your ultimate beneficiaries to receive monies at that time, e.g. as a result of their bankruptcy or ongoing divorce proceedings or if they should have inheritance tax concerns of their own.

In addition, if – as has historically been the case – the growth in the value of the nil-rate band does not keep pace with the growth in property/investment values, then an additional inheritance tax saving could be obtained by leaving the assets to a discretionary trust rather than to the survivor.

Even if such a trust were to arise on the first death then, under current legislation, if it were felt at that time that it would be preferable for the assets in the trust to pass to the surviving spouse this can be done within two years of the date of death in such a way so that the nil-rate band of the first to die can still be transferred to the surviving spouse.

In so far as your estate contains assets which would qualify for either Business Property Relief or Agricultural Property Relief from inheritance tax then the advice remains that in order to maximise the potential inheritance tax saving these assets should not be left to the surviving spouse but should instead either be left to your ultimate beneficiaries outright or to a discretionary trust.

c) Incorporate a life interest trust

A life interest trust can be equally as effective as a discretionary trust at protecting against re-marriage, bankruptcy, entry into long-term care etc and is usually much simpler to administer than a discretionary trust.

Such a trust gives guaranteed rights to the survivor, e.g. if the trust contains a property then the survivor has the guaranteed right to reside in that property, to request its sale and the use of the sale proceeds to purchase a replacement and to retain any rental income the property might produce.

Whilst the survivor only has a guaranteed right to receive the income produced by investments and has no right to the capital, it is possible to provide the trustees with power to advance capital to the survivor where they consider this to be necessary or desirable.

Unlike assets within a discretionary trust, assets within a life interest trust are amalgamated with the value of the survivor’s estate for inheritance tax purposes, meaning that the nil-rate band of the first to die is not utilised by such a trust. Pre-9th October 2007 this meant that the nil-rate band of the first to die would have been wasted but, post 9th October, the use of such a trust will not prevent the transfer of the unused nil-rate band to the surviving spouse.