Rising Property prices to cause inheritance tax problems
The most common type of will written for married couples is a wish to leave all their assets to each other on the first death and then pass them on to their children on the second death.
Such simple wills used to be the bread and butter of the legal profession. For Inheritance Tax purposes, no Tax is payable on the first death regardless of the size of the estate, by virtue of the spouse exemption and, in the past, the nil rate allowance (currently £275,000) was often enough to ensure little or no Tax arose on the second death.
However, the dramatic increases in property prices over the last few years have had a significant impact on the potential Inheritance Tax liabilities of many householders. When one considers what £275,000 would now buy, it is not difficult to understand how huge swathes of the population, who until a few years ago would either have paid no tax on the second death, or at the very least a manageable amount, now face potential Tax bills of hundreds of thousands of pounds.
The Discretionary Trust Loan Scheme is designed to allow married couples to leave all their assets to each other on the first death but effectively allow two nil rate allowances to be claimed on the second death before tax becomes payable.
It does this by creating a discretionary trust on the first death. In to that trust is put a sum equal to the nil rate allowance applicable at the time of death. However the will includes provision for the trustees of the Trust to accept an I.O.U. from the surviving spouse rather than cash. All of the assets then pass to the surviving spouse, subject to the debt.
The children (or other family members) are the beneficiaries of the trust and of the residuary estate of the surviving spouse. Therefore the family assets are passed down to the same beneficiaries, albeit via two different routes.
Before Tax becomes payable on the second death the debt owed to the trustees of the trust set up on the first death is deducted along with the survivor’s own nil rate allowance.
Example
A married couple who own assets worth £550,000 between them pay no Tax on the first death as they leave all to each other and therefore qualify for the spouse exemption. The size of the debt will be equal to the nil rate allowance applicable at death, currently £275,000. On the second death, the debt to the trust of £275,00 is deducted along with that person’s own nil rate, also currently £275,000. This leaves a net taxable estate of £nil and a zero Tax liability, as opposed to one of £110,000 if they had not had the trust in their wills.
This makes a saving of £100,000 tax, which directly benefits the couple’s children.
It should be noted that the Trust set up on the first death is a discretionary one and as such the trustees do not have to accept the I.O.U. from the surviving spouse. They could insist on receiving cash instead. It is also within the discretion of the trustees to decide who is to benefit from a list of beneficiaries specified by the deceased and in what proportions. For these reasons, it is advisable for a letter of wishes to be written expressing the testator’s intentions regarding the Trustees’ use of their trust powers.
Wills incorporating the Discretionary Trust Loan Scheme are becoming increasingly common. From my own experience I would estimate that around 90% of married couple wills I draft include the scheme. Given the Tax savings involved it is not difficult to see why as clients quite rightly believe they should do all they can to avoid their hard-earned money ending up with the Inland Revenue rather than their families.
There are many other ways in which the effects of Inheritance Tax can be mitigated and seeking advice from a specialist adviser is essential. Such advisers are not just to be found in London, where fees are exorbitantly high, but in many good High Street practices, which can be a very cost effective and equally professional alternative.
For more information please contact Whitehead Monckton on 01622 698000 or email us on enquiries@whitehead-monckton.co.uk
Author: Stephen Beck
Published: 12 December 2005