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Nil will for Jack and Jill

Planning Strategy – Paul Wilcox, chairman and technical director of The Way Group, sets out the advantages of nil-rate discretionary trusts over mirror wills.

Many people put off inheritance tax planning because it is a tax which affects their beneficiaries and not them. They believe the cost of IHT mitigation planning will be excessive, either in cost of insurance for instance, or they will lose control and access to their carefully acquired nest egg by gifting it outside their estate.

In fact, the solution for many taxpayers is incredibly effective and costs next to nothing other than a single consultation with a will-writing lawyer. This most common of measures is the nil-rate band discre-tionary will trust.

The best way to illustrate this most useful tax planning tool is to quote a basic example. Take Jack and Jill, who have joint assets, including their house, of £600,000. They are getting on a bit and, having seen IHT campaigns mounted in the national press, have finally decided to address their potential IHT problem.

Like many couples with children, they have conscientiously updated their wills on an irregular but frequent basis. Again, as with most couples they have mirror wills, which leave all their personal assets to their surviving spouse so their family is protected.

This is a perfectly sound approach during their youth when IHT is still a far-off concept which is irrelevant to their main family focus.

The difficulty with this approach only emerges later when the spectre of IHT appears. When someone dies, their assets can pass to their surviving spouse free of IHT under the inter-spouse exemption.

This is what tends to happen under conventional mirror wills where both partners gift all their assets to the survivor. But the difficulty comes when the survivor dies and only has a single nil-rate band to set off against what were really joint assets.

Let us assume that Jack dies at 76, at which point Mary is 72. Under his will, all his assets pass to Mary free of IHT. When she dies, she has an estate of £600,000 against which she can set her personal NRB of £300,000.

The balance of £300,000 is fully taxable at 40 per cent and the family reluctantly hand over £120,000 (the taxable excess of £300,000 at 40 per cent) to Gordon Brown’s successor.

The solution to this difficulty lies in making sure that Jack, the first to die, uses the whole of his own personal NRB before using the inter-spousal exemption to pass assets to Jill.

At death, he does this best by having included a nil-rate band discretionary trust within his will. Under this arrangement, he gifts assets to the value of his currently unused NRB (this distinction is important) into a discretionary trust of which his surviving spouse and children are beneficiaries.

This means that not only has he made a gift to use his NRB but also that those relevant assets do not go directly to Jill to put her estate into taxable territory. In spite of this, she will have access to those assets courtesy of the trustees.

The table here shows how the sums work for a joint estate of £600,000 – a sum exactly covering their two NRBs. As you will see, the benefits – a tax saving of £120,000 – are substantial.

For most potential IHT payers organising a discretionary will trust is a priority which comes a very close second to an enduring power of attorney.

What are the downsides of relying on a discretionary will trust to resolve IHT mitigation? There are none for the moderately wealthy because that action alone may take them out of the tax trap. For those that are better off, however, it is imperative not to leave IHT mitigation to one’s will. If one has a joint estate of £1m or £2m, then additional action is required well ahead of death,

The steps to be taken are similar to the discretionary will trust except that they are taken during one’s life. A taxpayer can readily use his/her personal NRB at any time by making a gift into trust. So long as he or she then survives seven years from making that gift, it falls out of account for IHT purposes.

If Jack and Jill had assets of £1.2m instead of £600,000, they would ideally have to use their own personal NRBs twice to be able to remove all their assets outside their Mirror trust NRB discretionary trust

Joint estate £600,000 £600,000Transfer on first death into trust Nil (£300,000)

Residue in survivor’s estate £600,000 £300,000Deduct NRB on second death (£300,000) (£300,000)

DeathNet subject to IHT £600,000 NilIHT @ 40% £120,000 NilTotal net estate remaining £480,000 £600,000estate and beyond the reach of the taxman.

They would make gifts equivalent to their NRB now and a similar sum in seven years time, removing it all from the reach of the taxman. Even at their ages, he is likely to live more than seven years and she is likely to survive more than 14 years.

It is extremely important that the trusts they use are specialist trusts which offer a high degree of flexibility in terms of getting monies back to the settlors (those having made the gifts) as well as making benefits available to family members in distress.

A word of warning here. The most popular and simplest arrangement available in the market today, the discounted gift trust, does not offer optimum flexibility for either the settlor or his/her beneficiaries. The first choice should always be flexible (non-discounted gift) trusts.

The message here is very clear. Everyone who may become a potential IHT payer should have a NRB discretionary trust incorporated into their will.

Couples with assets above their joint NRBs should establish flexible lifetime trusts as early as possible to start removing those assets beyond the reach of the taxman while keeping them accessible to family.

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