ABOUT THE AUTHOR: Stephen C Haggett TEP is
Director of Private Client Services at H & C Lawyers
F or those unfamiliar with the subject, the concept, at first
glance, appears to be a very simple one. For sometime, the law has
allowed certain post-death tax saving arrangements to be made
enabling beneficiaries under a will (or the intestacy provisions)
to vary their interest by ‘redirecting’ their inheritance. This has
usually been accomplished by a Deed of Variation (DOV).
Many advisors may have assumed that the need for such variations
have considerably diminished, particularly since the introduction
of the transferable nil rate band between married couples or civil
partners in their estate planning.
However, variations may still be highly attractive for a number
of reasons and their potential use requires careful consideration
as part of a family’s longer term strategic tax and financial
planning.
Whilst this article will focus on post-death variations,
advisors will need to appreciate that such arrangements may prove
to be too late in the context of asset protection.
Care fee planning, cohabitation, second marriages, financial and
wealth management concerns, etc, may become, over time, a factor
for many families and arguably there can be no substitute for
perhaps flexible will trust arrangements. The absence of such
planning may prove devastating and advisors could face demanding
questions from both families and professional negligence
lawyers.
This article will illustrate the potential use of variations by
reference to a family case study. Whilst the names maybe
fictitious, the facts are largely based on an actual client
scenario, although these have been updated to take into account
current tax rates and exemptions.Client study: The Wiseman
Family
Mr and Mrs Wiseman were a retired couple with two adult
daughters and a grandchild. Mrs Wiseman survived her husband by
approximately six years and on his death their combined asset
wealth was roughly GBP700,000, which had increased to GBP1.1
million by the time of the widow’s death. This comprised the family
home (GBP350,000), an equity portfolio (GBP500,000) plus a
City-based property (GBP250,000), which had been inherited from an
elderly sibling.
Whilst the planning was largely motivated by inheritance tax
(IHT) there were also various non-tax factors, including the
youngest daughter’s acrimonious divorce and who for a period lived
in the City property as a result.
The clients also found the property a useful retreat on their
regular pilgrimages to London.
Practitioners will be familiar with the legislation introduced
by the Finance Act 2008 allowing the estate of the
surviving spouse (or civil partner) to claim, from 9 October 2007,
the IHT exemption unused upon the first to die: the concept of the
transferable nil rate band.
As a result many clients appear to have envisaged a return to
much simpler estate and succession planning. Clients may now assume
(or have been advised) that only a simple will needs to be made,
leaving everything to the survivor on the first death in the
knowledge of a 100 per cent uplift in the surviving estate’s nil
rate band (individual IHT exemption and for 2009/10 and 2010/2011
GBP325,000). This assumes that there are no complicating factors
such as gifts with reservation of benefit or failed life time gifts
(potentially exempt transfers), etc.
Such couples might feel that they can now happily die in the
perhaps mistaken belief that such simple will planning does not
prejudice the IHT burden or expose their wealth to other
perils.
In the absence of any planning, the effect of such simple wills
in the context of our client family can be illustrated by the
calculation at Table A which shows the IHT position on Mrs
Wiseman’s death.
Before October 2007, Mrs Wiseman’s advisors might have suggested
a variation to her late husband’s will to carve out a nil rate band
discretionary trust to preserve the benefit of his IHT exemption,
assuming their estate planning had not already employed such
arrangements.
Is this now unnecessary after October 2007?
Arguably, suitable trust arrangements provide enormous
flexibility enhancing a degree of security in carrying out the
clients wishes. Considerable IHT savings can also be achieved.
In the context of our sample clients, with careful planning
equity based assets were appropriated into a discretionary trust
created on Mr Wiseman’s death to the value of his then available
NRB (GBP285,000). The portfolio subsequently increased in value to
GBP450,000 by the time of his widow’s death. The resultant IHT
position (and tax saving) is shown in Table B.
Greater opportunities may present themselves if assets can be
appropriated during a recessionary dip in the global economic
cycle.
This was a second trust for the family as the London property
had been redirected into a discretionary trust under a variation to
the sibling’s will. The IHT result of this can be illustrated in
Table C, which shows the reduced tax liability on Mrs Wiseman’s
death.
It is worth remembering that in the ‘real world’ it is not
possible to vary a person’s will and therefore any variation is
treated as a gift on the part of the beneficiary redirecting their
inheritance. However, variations have for some time provided a
unique tax planning opportunity particularly in the context of IHT
planning, although myriad taxes will play a part in the overall
financial jigsaw puzzle, which need to be considered. Non-IHT taxes
will be considered in a future article.
Table A |
Mrs Wiseman’s personal estate at her death (no planning) |
GBP |
Main home |
350,000 |
City property |
250,000 |
Investment portfolio |
500,000 |
|
1,100,000 |
Less IHT exemptions |
650,000 |
Net taxable estate |
450,000 |
IHT payable @ 40% |
180,000 |
Table B |
Mrs Wiseman’s personal estate at her death |
GBP |
Family home |
350,000 |
London property |
250,000 |
Investment portfolio (balance) |
50,000* |
|
650,000 |
Less IHT exemptions |
325,000 |
Net taxable estate |
325,000 |
IHT payable @ 40% |
130,000 |
NB *GBP450,000 sheltered within husband’s
discretionary trust |
Table C |
Mrs Wiseman’s personal estate at her death |
GBP |
Family home |
350,000 |
Investment portfolio* |
50,000 |
|
400,000 |
Less IHT exemptions |
325,000 |
Net taxable estate |
75,000 |
IHT payable @ 40% |
30,000 |
NB *GBP450,000 sheltered within husband’s
trust
GBP250,000 property sheltered within sibling’s trust |
Variations: inheritance tax treatment
Assuming a beneficiary varies in accordance with the conditions
set out under S142(1) Inheritance Tax Act (IHTA)
1984 then the results can be extremely favourable indeed.
It is commonly said that the terms of any variation are ‘read back’
into the deceased’s will. HMRC accept S142(1) includes all IHT
legislation and encompasses the reservation of benefit legislation
found in the Finance Act 1986.
It is therefore possible for a beneficiary to redirect their
inheritance into a discretionary trust for a wide class of
discretionary objects and for such property not to be caught by
these rules even if the original beneficiary (or spouse) continues
to derive a benefit from it. In theory there is also nothing to
prevent the original beneficiary from being one of maybe several
trustees and therefore have some control over these arrangements.
Although in our family scenario relevant property trusts have been
created such settlements will not be ‘settlor interested’ for IHT
purposes and will be treated as having been made by the
deceased.
There are however various conditions for S142(1) to apply. For
instance any variation must be in writing and made within two years
of the deceased’s death. Since 2002 no formal election needs to be
submitted to HMRC, although the instrument of variation must
contain a statement that the provisions of S142(1) are intended for
the Act to apply. A failure to contain such a statement would
invoke the reservation of benefit rules and lead to the creation of
a relevant property trust on the part of the original beneficiary.
Other conditions also apply.
Clients may find it very beneficial to employ the flexibility
exploited by the Wiseman’s in preserving all available nil rate
bands, enabling trusted advisors and families to take all potential
factors (fiscal and non-tax alike) into account at the relevant
time.
For example, consideration will need to be given as to whether
certain decisions are made within two years of the deceased’s death
because of the provisions of S144 IHTA. These rules allow trustees
of a discretionary will trust to exercise their powers of
appointment within two years of death to ensure ‘reading back’ for
IHT purposes, i.e. by ignoring the relevant property trust.
Appointments can be made outright or to create a qualifying
interest in possession.
Powers exercised outside this period do not give rise to the
creation of an immediate post death interest with the trust
remaining within the discretionary regime. Changes to the
underlying beneficial interests can therefore be made within the
trust with this being a non-event for IHT purposes as a result of
the Finance Act 2006.
Conclusion
Whilst there are traps for the unwary, the advantages of
preserving all available nil rate bands as part of a family’s
longer term holistic planning can yield enormous tax benefits. It
also enables a substantial degree of flexibility by allowing
trusted advisors and trustees to manage, protect and distribute
wealth. Even for clients of modest wealth, this can help prevent
the desecration of hard earned family assets particularly against
the rising costs of care and the growing tide of divorce and other
associated risks now faced by many families.