IHT-Solutions

An alternative way of saving IHT via your Will

Whilst nil rate band discretionary loan trusts are often the chosen course by practitioners within Wills to save clients inheritance tax, they are not the only option. I have seen a number of married clients recently whose joint estates exceed the nil rate band (currently £285,000) but not by a substantial amount, often by about £75,000. In addition, the vast majority of their estate is tied up in their matrimonial home.

I advise that on the basis that they at least survive until the 6th April 2007 when the inheritance tax threshold is raised to £300,000, their tax liability will be approximately £25000, on the death of the survivor of them. The perceived complexity of setting up a nil rate band discretionary loan trust for the relatively small potential tax liability means that the clients are not always keen to go down the discretionary trust route.

As an alternative, I have proposed Wills in the following manner which has found favour with some clients:-

For the example the following assumptions are made.

The value of the joint married couple's estate in question is £360,000 of which the matrimonial home is valued at £300,000.

The nil rate band is also £300,000 leaving a potential liability on the second death of £24,000 (40% of £60,000.)

The solution is for the matrimonial home to be held as joint tenants in common so that each party owns a 50% share in the property each and for the Will to give a gift of a percentage of the share of the property owned by the first party to die (say 40%) to the children of the couple.

In this example, the children on the first death will own a 20% share of the whole property (40% of one-half with a value of approximately £60,000). This, therefore, reduces the value of the survivor’s estate by a sufficient sum to avoid inheritance tax whilst still enabling the survivor to remain in the matrimonial home. The share owned by the children will be too small for them to force a sale of the property without the consent of the survivor

If the survivor wishes to downsize, then the children will get their relevant cash sum out of the net sale proceeds but the survivor will still generally have sufficient assets left to live comfortably.

As the element of the property left to the children is relatively small, no real capital gains tax issues arise for the children.

Evidently, each case must be judged on its own merits and, in particular, a couple must be confident that they are comfortable with making a gift of this nature on the first death and that they otherwise have sufficient financial resources and pension income in place for the survivor.

Taking all these points into consideration, Wills of the type envisaged by this post (and indeed a Deed of Variation within two years of a first death) do offer a relatively simple inheritance tax solution for smaller, property heavy estates.

Remember, just because IHT is charged at 40% does not mean that your estate will be charged at the same rate

In today's post, I will prove that Inheritance tax is actually, a progressive tax, despite the 40% death rate potentially applicable to all estates.

The maths are simple. In all the following examples, we shall assume the nil rate band applicable as at the 6th April 2007 in the sum of £300,000 and further assume that no inheritance planning of any type has taken place.

1. An estate worth £350,000 - IHT payable: £20,000 (40% of £50,000). An effective tax rate on the total estate of just over 5.7%.

2. An estate worth £500,000 - IHT payable: £80,000 (40% of £200,000). An effective tax rate on the total estate of 16%.

3. An estate worth £1,000,000 - IHT payable £280,000 (40% 0f £700,000). An effective tax rate on the total estate of 28%.

As a result, one could argue that a lower-valued estate which falls just above the IHT threshold does not really have to worry about Inheritance tax whilst those who have much larger estates have the resources to carry out sufficient tax planning during their lifetimes to avoid inheritance tax all together.

The truth, of course, is that the vast majority of people resent paying tax generally and they particularly resent paying inheritance tax which is a tax on those resources they have accumulated during their lifetime after payment of taxes throughout their lives.

Obviously, the relevant rate of inheritance tax and the IHT threshold can only be dictated by the politicians and they may or may not react to the concerns of the electorate. It is the job of this blog and similar publications to remind all inheritance tax payers whether of smaller or larger estates that they can often mitigate their inheritance tax liability substantially by careful inheritance tax planning throughout their lives and especially in their retirement years.

Tenancy in Common - explained

Ordinarily, in order to put in place a nil-rate band discretionary loan Trust Will effectively to save inheritance tax, it is necessary to ensure that the relevant married couple (or civil partners) own their property as joint tenants-in-common.

This language is quite legalistic and a number of my clients are unsure as to exactly what a "tenancy in common" means.

I shall attempt in this post to simplify so far as possible the concept as follows:-

Firstly there are two ways by which property can be jointly owned.

a. A joint tenancy. This means that upon the death of one party the property automatically falls into the ownership of the survivor(s) at the moment of death. The important element for tax planning is that the Will or intestacy of the deceased only takes effect at the moment after death.

b. A joint tenancy-in-common. Under this form of ownership, the property is usually held in two separate equal shares of 50% each but can also be held in unequal shares if required. The big difference to a joint tenancy, however, is that the relevant share of property on death can only pass under the terms of the Will of the deceased or their intestacy.

When a nil rate band discretionary loan Trust Will is set up, it is usual for a property to form a major part of the estate. Under the terms of the Will, the deceased will pass the relevant share of their property into a discretionary trust.

As you can see above, if property is held as joint tenants, the property cannot pass under the terms of the Will, hence the need to ensure that property is held as joint tenants-in-common when a relevant couple enter into nil rate band discretionary loan Trust Wills.

The good news is that it is relatively easy to convert a joint tenancy into a joint tenancy-in-common if all parties consent. Ordinarily, the solicitor will prepare what is known as a Notice of Severance to be signed by the parties and this is then registered free of charge at the Land Registry and the joint owners are officially registered joint tenants-in-common.

The "magic" 2 years in which to save IHT

Whilst whether we like it or not, death is one of the few certainties in life, death in itself is not the final word when it comes to the saving of inheritance tax.

For up to 2 years after the date of death, beneficiaries of a Will or intestacy can gift their share of an estate to anyone or any organisation of their choosing without penalty, by virtue of what is known as a Deed of Variation. There are, of course, a number of reasons why Deeds of Variation are entered into, not the least being the saving of inheritance tax.

On a regular basis during my working life, I meet widows and widowers who are beneficiaries of simple Wills left by their deceased spouse leaving everything to them. Indeed, until 5 or 6 years ago, Wills of this type for the vast majority of married couples were very often highly suitable. As a result of the large increases in property prices over the last few years, many of these clients are now finding that the estate of the surviving spouse is now well in excess of the nil rate band of tax (currently £285,000). As a result, upon the death of the surviving spouse, there will be inheritance tax payable at a rate of 40% on any assets in excess of the nil-rate band. This will in many instances result in a tax liability upon the survivor's death in excess of £50,000.

This is where the Deed of Variation and the "magic" 2 years comes into play. Under the Deed of Variation it is possible to re-write a Will and even retrospectively sever a joint tenancy to ensure a property is held as tenants in common. Accordingly, the surviving spouse can set up the tax efficient nil rate band discretionary loan trust Will referred to in previous posts, even though their deceased spouse never changed their Will to this effect during their lifetime.

Of course, the right to make a Deed of Variation may be removed and as a result I would always advise clients to make an up to date professionally drawn Will. For the time being, however, the Deed of Variation in many cases gives an excellent escape route in the battle to save IHT.