Examples of Tax Planning savings
Why pay IHT for every generation?
If you are planning to leave your estate to someone who is well off in their own right you should consider using a Will Trust to reduce overall Inheritance Tax (IHT) exposure.
For example, IHT charges can erode the value of a £300,000 legacy to just £108,000 if left outright to children who then pass it on to grandchildren.
(On first death £300000 – 40% tax = £180000. On second death £180,000 – 40% tax = £108000)
Using a ‘Will Trust’, you can avoid the second charge (£72000) but still allow your children to benefit, during their lifetime, from either the trust income or the underlying capital.
There are usually some IHT charges levied on the assets in trust, but these are a maximum of 6% every 10 years, and to the extent that your children (or primary beneficiaries) don’t need the underlying capital it is protected for future generations (secondary beneficiaries).
The impact of 'single grossing' on badly drafted wills
George has only months to live and is about to draw up his last Will & Testament.
He is worth £10m, and proposes to leave £3m to his son, Robin, with the balance going to his wife, Mildred.
Gifts he has made during his lifetime have used up the whole of his ‘nil rate band’, so whilst he is aware that the £3m he is leaving to his son will be fully taxable, he is consoled by the fact that the whole of the gift to his wife is exempt.
The IHT rate is 40% so that should mean a tax bill of £1.2m (£3m@40%), with post-tax receipts of £7m going to Mildred and £1.8m to Robin.
Luckily for George he mentions his plans to his accountant and is surprised to learn that unless he changes the way his will is drafted, his estate will actually pay £2m in Inheritance Tax and that all of the tax will come out of his wife’s share of his estate – i.e. Mildred will receive £5m (instead of £7m), Robin will receive £3m (instead of £1.8m) and HMRC will receive £2m (instead of £1.2m).
This is all because George is proposing to leave a ‘specific legacy’ of UK property worth £3m to Robin and the ‘residue’ (or balance) of his estate to his wife. For reasons that George was unaware of that means the £3m is treated as having been received by Robin net of 40% IHT and that tax due on the gift is £3m x 40/60ths = £2m. Furthermore, the tax is payable by Mildred’s (exempt) residue, so the estate pays £800k more in tax and Mildred gets £2m less than was intended.
Fortunately, this outcome can be averted and George can achieve his desired outcome if he takes some professional advice.
A waste of Business Property Relief
Donald died 6 months ago and when his executors draw up estate accounts they show that he had net assets of £1.2m. Out of that sum, his Will states £500,000 cash should go to his wife, Doreen, and the balance (further cash of £400,000 and a business worth £300,000) has been bequeathed to his son, Bruce.
The gift to Doreen is exempt (as a gift to spouse) and the gift of the business qualifies for 100% Business Property Relief (BPR), so prima facie, that leaves just £400,000 taxable. Furthermore, as Donald had made no lifetime gifts, his executors have the full Nil Rate band of £325,000 available to offset against the £400,000. The executors do some quick calculations and think there will therefore be £30,000 in Inheritance Tax to pay ((£400000-325000) x40%) and that Bruce should therefore receive net cash of £370,000, along with the business, whilst Doreen will get the full £500,000 in cash.
Unfortunately…, the executors haven’t factored in s39A IHTA 1984 (commonly referred to as ‘the spreading provisions’) which operates to partly reallocate BPR on business assets that are left to ‘residue’ against specific legacies.
If those specific legacies are ‘exempt’ this has the effect of wasting the BPR.
In this particular instance £125,000 of BPR is reallocated to the already ‘exempt’ cash legacy to his wife, leaving just £375,000 of the £500,000 exempt whilst increasing the value of residue that is chargeable to IHT by the same figure. A badly drafted Will has thereby effectively wasted BPR and increased the Inheritance tax bill by £50,000 to £80,000.
Fortunately…, all is not lost. Provided the executors’ advisers recognise the problem quickly there is still time to restore the balance.
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