The foundation stone

news: The foundation stone

THERE IS no point attempting UK inheritance tax planning without first having a Will in place. A Will should be one of the most important tax planning tools for any individual who has someone who is, even if only in part, financially dependent on them. It is also an integral part of inheritance tax planning.

Both a husband and a wife have a nil rate band for inheritance tax (£263,000 for 2004/2005), yet many married couples make Wills that simply leave everything to each other. You should be aware that, as transfers between spouses are exempt from IHT, this strategy in effect wastes the nil rate band on the first death. By writing a Will trust, on the first death, assets to the total of the nil rate band in that year will pass not to the surviving spouse but to the Will trust, thus making full use of the nil rate band on first death.

The surviving spouse can take loans from the trust that are repayable on death, leaving the surviving spouse with the security of being able to access those assets housed within the trust. On the second death, at which point the second nil rate band will be utilised, the assets of the trust pass to the beneficiaries. This simple planning tool, under the current rates, will save up to £105,200 of IHT. The surviving spouse should be set up as a trustee as they then have an element of control over how the assets are used, including whether or not they are disposed of. On the surviving spouse’s death, however, any funds remaining in the trust can pass on to the children free of IHT. If assets are gifted away instead of put into trust, then the surviving spouse needs to live for a further seven years for there to be no IHT due on the value of the gifts. If everything is simply left by one spouse to the other on first death then, on the second death, the estate will include the assets of both parties so all that happens is that IHT is deferred rather that reduced.

It should also be remembered that any asset that goes into the trust must have been owned by the deceased and be capable of being passed on through a Will.A home cannot be passed into a Will trust if it is owned on a joint tenancy basis because ownership automatically passes to the surviving spouse. One solution is to change the basis of ownership to tenancy in common, where ownership of each share passes in accordance with the terms of the deceased’s Will.Again, couples can take advantage of both nil rate bands. It is a fundamental principle of inheritance tax, that an individual who has interest in possession in a trust fund is deemed to have the trust fund in his/her estate for tax purposes. Hence, Will trusts are usually designed not to have interest in possession although the Inland Revenue will examine cases to determine if, in reality, the trust creates such an interest.

However, there may be difficulties when the surviving spouse occupies the family home. As the house, or a share of it, is an asset of the trust, the surviving spouse must be a beneficiary.The natural approach is to ensure the surviving spouse is given a right under the terms of the trust to remain in occupation as long as they wish. That would be fatal to successful inheritance tax planning because providing a surviving spouse with a right may trigger an interest in possession issue. The latest thinking is not to use a share in the home as an asset for the trust, but to accept an IOU from the surviving spouse as a trust asset.All the deceased’s assets pass to the survivor and in return, the survivor gives the trustees an IOU to the value of the nil rate band.On the survivor’s death the trustees call in this IOU that would normally be met from the proceeds of selling the house.

However, there are also capital gains tax issues. When a matrimonial home is left to the surviving spouse outright, or the survivor has a right to occupy the home, its value will be included in the estate but there will be no CGT charge on any increase in the property’s value. If it is left to a discretionary trust or children and they allow the surviving parent to occupy the house, on its sale there could be problems with security of tenure as well as a CGT charge to those not occupying it. The exact nature of the relationship between the couple is also key, for example, if the surviving spouse is not UK domiciled, the IHT exemption is limited to £55,000. The IHT nil rate band is only attributable for married couples.Even if the couple is separated, the IHT rules count them as still being married if the decree absolute has not been issued.

The Civil Partnerships Act 2004 gives legal recognition to same-sex couples. Schedule four of the Act amends enactments relating to Wills, administrations of estates and family provision so they apply in relation to civil partnerships as they apply in relation to marriage.While the Act itself does not specifically mention tax, the government has said this year’s Finance Bill will include provision for same-sex couples to get the same tax breaks as married couples.

IHT planning and Wills are inextricably linked, a Will is necessary as a foundation stone for successful financial planning.There is no point looking at IHT without having a Will in the first place. How a Will is written, along with the tax efficiency of the way an individuals assets are arranged by their adviser, will dictate the tax position – and importantly, the tax bill – of the client’s beneficiaries. Therefore it is vital that advisers have an all-round view of their own client’s affairs as well as who will be affected on their client’s death and, in this respect, will be best served by their financial adviser and solicitor working together and combining their knowledge and skills.

My key message is that we need to know all options that solicitors use, as financial advisers can then incorporate their ideas on top of the solicitors to maximise IHT mitigation on behalf of a client. There is very little point in putting estate planning in place if a suitable Will is not firstly in place. A solicitor will need to liase with the financial adviser about any financial assets held when writing up the Will, while the financial adviser will need to liase with the solicitor about what money may be given for investment. It should be remembered that a well constructed Will always forms a key part of any estate planning exercise, also any Will that is written should be regularly reviewed in order that it always reflects the true circumstances of the assets and family it seeks to assist.