Intergenerational Planning – Gifting through will planning

Learning Objectives:

• To understand and be able to explain how to calculate IHT on death and how the nil rate band and residence nil rate band affects the calculation
• To understand how a discretionary will trust works , what it can achieve and how it is taxed
• To understand how an interest in possession  will trust works , what it can achieve and how it is taxed 

Alan & Brenda, aged 73 and 70 respectively are married with two adult daughters, Chrissy and Danielle.

Chrissy is married with 2 children; while Danielle has recently become engaged to her on-off partner, Ed.

Alan and Brenda have a joint estate of £2,160,000 made up as follows:

Their Wills are currently written leaving everything to the survivor on first death and then to their daughters in equal shares on second death

They have no liabilities.

Alan and Brenda’s Objectives

·         Retain full control over and access to their assets and investments in their current format (i.e. with no material reinvestment) during their lifetimes

·         Subject to the requirement for access, to maximise the available inheritance tax (IHT) reliefs,, allowances and exemptions available so as to minimise the impact of IHT on the estate

·         Ensure that any property or investments left to their daughters (and in particular, to Danielle) is ring-fenced within the ‘blood-line’ and is prevented from passing outside the family in the event of, for example, a future death or divorce

Analysis 

By leaving everything to the survivor on first death and then to children on second, there will be no IHT on first death but a liability of almost £500,000 on the death of the second to die. This is calculated as follows:

* the AIM shares

** the deceased’s nil rate band and that “inherited” from the first of the couple to die

***Part of the residence nil rate band (which is £350,000 for the second of a married couple to die when the residence nil rate band is not used on first death) is lost as the survivor’s estate exceeds £2m. Note that assets qualifying for business relief are included for the purposes of determining whether the estate exceeds the £2m threshold. Where the estate exceeds the £2m threshold, the residence nil rate band (RNRB) is subject to tapering at a rate of £1 for every £2 by which the estate exceeds the threshold. As Alan and Brenda’s joint estate exceeds the threshold by £220,000 (£2,130,000 plus the £90,000 AIM shares) , £110,000 of the potentially available RNRB is lost.

As both are in their early seventies, it is highly likely that assets will increase in value between now and second death. This means that at the point of second death, the RNRB could be lost altogether creating an extra IHT liability of up to £140,000 (in addition to the additional IHT due on the increase in value of the estate)

Possible solution

Part 1 – First death discretionary will trusts

Loss (or tapering) of the RNRB on second death could be prevented (or the impact of tapering significantly reduced) by both parties revising their Wills so that assets up to the value of the nil rate band pass to a discretionary trust on first death. The benefits of this approach are:

• Two nil rate bands will still be used however, a lower amount will pass to the surviving spouse on first death. This means that there is more chance that the estate on second death will be below £2m and that two RNRBs (worth an IHT saving of £140,000) will also be available to offset against the second death estate;
• The surviving spouse will be a potential beneficiary of the nil rate band discretionary trust, meaning that they will have continued access to the investments held within it without those investments forming part of their estate for IHT purposes;
• Any investment growth on the trust fund that accrues between first and second death will also be held outside of the estate of the survivor;
• If the surviving spouse needs access to the trust fund, the trustees could choose to make the required funds available in the form of loans. Provided that any such loans are repaid to the discretionary trust on second death, they will be deductible from the estate before IHT is calculated, thereby creating further IHT savings;
• Chrissy and Danielle will also be potential beneficiaries under the nil rate band discretionary trust and so will be able to receive distributions of income, capital and/or loans from the trust at the discretion of the trustees; however, they will have no entitlement to the trust fund meaning that it is shielded from possible third-party claims.
• If Alan died first, his AIM shares could also be left to his discretionary will trust. There would be no IHT on transfer due to the availability of 100% business relief, a further reduction in the amount passing to the surviving spouse for the purposes of determining eligibility for the RNRB and if the shares were sold post-death, the proceeds would not be in the estate of the surviving spouse and potentially subject to 40% IHT on her death.

Part 2 – Residue left on interest in possession trusts for Chrissy and Danielle

The RNRB is only available where the home is ‘closely inherited’. Broadly, this means inherited by children or grandchildren (or the spouses, civil partners, widows, widowers etc of children or grandchildren). At present, Alan and Brenda’s estate passes to Chrissy and Danielle outright on second death, however, this doesn’t accord with their objective of keeping assets ring-fenced within the family and protecting it from third-party claims.

What is often not realised is that the home will also be deemed to be ‘closely inherited’ if it is deemed to have passed to children, grandchildren etc for IHT purposes. While this precludes the idea of leaving the home to a discretionary trust on second death, there is an alternative – the home (and the remaining estate, if desired) could be left to an interest in possession trust. An interest in possession created on death is known as an immediate post-death interest (IPDI). For IHT purposes (including for the purposes of the RNRB rules), a person with an IPDI is treated as owning the underlying trust assets for IHT purposes.

Despite this, the person or persons with the IPDI have an entitlement only to the income generated by the trust assets (or, in the case of a property, to occupy it) – they do not own the trust assets for any other purpose than IHT purposes. This means that if the Wills of Alan and Brenda are revised so that the residue of their estate on second death passes to an interest in possession trust where Chrissy and Danielle have the interest in possession:

The home will be treated as having passed to the Chrissy and Danielle for RNRB purposes – thereby ensuring that the RNRB is available to the estate;

• Chrissy and Danielle will have the right to receive any income generated from the investments held in the trust (including from the reinvestment of the proceeds of sale of the family home if it is sold);
• Chrissy and Danielle will also be able to benefit from the underlying capital at the discretion of the trustees; however,
• They will have no entitlement to capital, meaning that the trust capital is protected from passing outside the family in the event of a future death or divorce.

Meeting Alan and Brenda’s Objectives

The two-part plan outlined will substantially enable Alan and Brenda’s key objectives to be achieved. Namely:

• Retain full access to their assets and investments during their lifetimes
• Maximise the available inheritance tax (IHT) reliefs, exemptions  allowances available so as to minimise the impact of IHT on the estate
• Ensure that any property or investments left to their daughters (and in particular, to Danielle) is ring-fenced within the ‘blood-line’ and is prevented from passing outside the family in the event of, for example, a future death or divorce