Will power is still vital

24 May 2010 8:00 am | By Lee Jones

Recent changes to the way that inheritance tax is applied by HM Revenue & Customs has led to the belief that a lot of estate planning, in particular using a will as part of IHT planning, is now redundant.

But Mills & Reeve associate John Grundy points out there are several circumstances where the creation and regular maintenance of an up-to-date will is critical in IHT planning.

Grundy says: “Since 2007, when the ability to transfer the £325,000 nil-rate band between couples was introduced, the finance community has assumed that there is no need for trusts in wills. Many think that requirement has gone because there is now the ability to claim the first spouse’s IHT-free allowance, effectively allowing the second person £650,000 passed on, IHT-free.”

He points out that in many cases, a deceased’s financial affairs may not be totally straightforward and a will can be essential to avoid confusion and any excessive tax liability.

Grundy says: “Non-doms, for example, do not apply to the 2007 rule. Anyone who is a non-domiciled spouse is an exemption to the rule and his or her threshold can be capped at £55,000. An IFA needs to check when helping with IHT planning whether both people in the couple are UK domiciles.”

Grundy says a will can be used to effectively pass on assets on first death rather than see assets subject to tax at a later date if they breach the £325,000 threshold.

’There are pitfalls and traps in IHT planning and if the will is not drafted so as to make use of all allowances, then they are going to be lost for ever’

“To pass on assets, you could use a life interest trust in favour of the surviving spouse by way of a conduit trust, in other words, you could put assets into the trust so they qualify for spouse exemption on the first death and then, immediately after the second death, transfer them to the children.

“In this case, they would be treated as gifts from the surviving trust from an IHT point of view and they would then only suffer an IHT charge if that survivor did not live for a further seven years. From a long-term planning perspective, this is prudent because if the funds are passed through a trust, then the children in the future can avoid IHT problems of their own.”

Grundy also points out that it is important to establish if clients have been married before or if they are a widow or widower as this can have a significant impact on IHT planning.

He says if IFAs come across a surviving spouse who has been left the whole of the estate and the deceased has not made use of their nil-rate band, then effectively it is possible to get hold of that allowance and make use of it on their own death.

Grundy says: “This is useful in a second-marriage scenario with a widow and a widower that have both have been left their tax-free allowances because ultimately you are able to use four nil-rate band allowances between the two of them which is a very significant £1.25m break between them.

“But to do this, a will must be drafted because if the nil-rate band of the former widow is not claimed on the first death it cannot be claimed on the second, so the will must provide the maximum amount goes into a trust rather than outright to the survivor. I can certainly see scenarios where disappointed clients complain that their adviser did not tell them that they needed the allowance on the first death. A situation like this may be something that is not often caught by advisers, as they are not always digging deep enough to ascertain the
background information on the clients.”

Other issues where a will can help include the inheritance of business and agricultural properties, assets that qualify for business property relief.

Grundy says, for example, if a man who owns 100 per cent of the shares of his business dies and leaves all the business to his wife it is likely that the business will be sold, so the wife is left with a pot of cash that suffers a 40 per cent charge to IHT.

Grundy says: “A much better plan would have been to make sure the will ensures that the shares pass into a discre-tionary trust controlled by the widow. It would keep the value of those assets outside of the wife’s estate for IHT purposes, saving the IHT for whoever ultimately benefits from the estate.”

Grundy also says wills can also be important for IHT planning where partners are not married.

He says: “There are a lot of cohabitants in the UK and, as far as the law is concerned, you might have lived with someone for 25 years but spouse exemption does not apply as on the first death there will only be one allowance on the nil-rate band, anything else suffers at 40 per cent. To avoid paying IHT when the first partner dies and then again on the second death, one would need to set up a will with a discretionary fund on the first death to avoid the double-charge.”

Grundy says that despite assumptions to the contrary, estate planning and using a will correctly are as important as ever. In fact, with some of the rule changes brought in, the need for a full, in-depth analysis of a client’s personal situation is more important than ever for effective IHT planning.

He says: “Gone are the days that the advice was to make sure you have a nil-rate discretionary band in the will and then it does not matter what else. There are pitfalls and traps in IHT planning and if the will is not drafted so as to make use of all allowances, then they are going to be lost for ever.”

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