The nutty problem of contingent pecuniary legacies
An interesting recent thread on the Trust Discussion Forum reveals how easy it is to do what the client asks and believe you have drafted a simple clause which will do precisely what the client wants but yet cause probate mayhem.
I am all for simplicity but will the outcome work in the way anticipated by the client if technical words are not used? Sometimes what is required may seem to a lay person legal jargon but nevertheless it is necessary. Our job is then to explain what the words do and why they are needed.
Take for example Uncle Joe’s Will. He wants to leave £100,000 to his great niece Louise if she attains 25 and the residue of his estate to his niece Katy. Katy is 30 years old and married to David; her daughter Louise is 3 years old. Joe has no other relations and has never married so his sister’s family are important to him. He is worth about £300,000.
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Joe needs to be acquainted with the available options and their different outcomes in terms of probate, trusts and tax. It may colour his thinking. If he wants to provide a nest egg for Louise
- Does he want the money to go straight away to Louise on his death so that Katy & David would receive it and manage it for her?
- Does he want her to have access to capital between now and 25?
- Does he want the money managed so that she can enjoy income arising on the capital and any capital growth?
- Does he want her simply to have the capital sum if she is 25?
Joe may feel that you are making a mountain out of a molehill but consider since he is not the parent of Louise nor does he have parental responsibility for her then he is not able to make bereaved minor trusts under s.71A or Aged 18-25 trusts under s.71D IHTA 1984. He can make an outright gift which is either vested or contingent; an immediate post-death interest trust under s.49A IHTA 1984 if we amend s.31 Trustee Act 1925 or otherwise he is making a relevant property trust. These do have different tax and administrative consequences.
Vested or contingent?
The Will draftsman must ensure that he distinguishes between beneficial entitlements that are vested and those that are contingent on the happening of a certain event such as the attainment of a specified age.
A minor (i.e. a person under the age of 18) cannot legally give a valid receipt for a legacy or a share of residue, (so this is often provided for in the Will, permitting the infant’s parent or guardian to provide the receipt to the PRs) but in the absence of any condition affecting such a gift he does nevertheless have a vested interest in it.
A gift to a beneficiary ‘on attaining the age of 18’ probably creates a vested interest as it is suggesting the money belongs to the legatee but cannot be paid until he reaches 18. Although he is not entitled to receive the capital until he is 18, the income earned from the capital may be paid to him by the personal representatives or accumulated and paid to him with the capital at 18. The asset would be part of his own estate if he died after the testator but before reaching 18.
Legacies or shares of residue are contingent if they are given on a condition precedent i.e. if there is an obstacle to be overcome and a failure to surmount that obstacle means no entitlement; for example a gift expressed to be ‘if they attain the age of 18’ or with some other similar condition. In that event the personal representatives must identify the beneficiaries who would be entitled to that asset if the original beneficiary failed to attain the appropriate age or otherwise comply with the terms of the Will.
Care is needed depending upon whether the gift is a pecuniary legacy; a specific legacy or a gift of residue and whether therefore the income arising between the testator’s death and the satisfaction of any condition belongs to the legatee of the gift or beneficiaries enjoying the residue.
If Joes simply said:
“I give to my great niece Louise the sum of £100,000”
this would not be a contingent gift. Instead it would be an immediate gift on his death to Louise even if she was under 18 at Joe’s death. It is the easiest approach since the money would belong to Louise directly on Joe’s death and would form part of her estate if she dies. Any income earned between Joe’s death and Louise reaching 18 would also be hers and would be added to the capital; however, it does not satisfy Joe’s requirement that Louise should not get the money until she is 25.
This approach is known as a ‘bare trust’ and effectively would need the direction that the money could be paid to Louise’s parents or guardians if she were under 18 at Joe’s death. It is administratively simple and ensures Louise’s own rate of income tax will apply to any income arising and may be appropriate in cases where smaller amounts of money are proposed.
Contingent pecuniary legacy
If Joe said:
“I give £100,000 to my great niece Louise if she attains the age of 25”
then this produces a tricky outcome. The income arising between date of Joe’s death and Louise reaching 25 is not payable to Louise because the legacy is only due to be paid at the date she reaches 25 and not before – she has no entitlement to it because she may never satisfy that contingency. So the income on the money would belong to Katy as residuary beneficiary and she would have to declare it.
It would not be possible to appropriate the legacy of £100,000 at the date of death by putting it into a separate bank account as it is part of the residue which may be called upon should Louise satisfy the contingency. Investment is therefore a problem as the specific sum of £100,000 has to be handed over in due course so investing in something which might produce £100,000 in 22 years is embarking on an exercise in risk management – there has to be a specific sum available on the due date which is pretty impossible to get spot on unless you can find guaranteed growth bonds which are tax free!
The case of Re Raine  1 Ch 716 established that intermediate income is not payable on a contingent pecuniary legacy unless there is an express testamentary provision to the contrary. This means if Joe would like to set aside a sum on his death which was to be for Louise together with any income he would need to say instead:
“I give to my great niece Louise the sum of £100,000 if she attains the age of 25 and this gift shall carry its intermediate income”
There is a statutory exception in s.31(3) Trustee Act 1925 which would avoid the need to mention the intermediate income but this would not apply in Joe’s case because he is not Louise’s parent nor is he someone with parental responsibility for Louise. He is also seeking an age greater than 18 as his chosen contingency. The exception would also not apply if the legacy was made to trustees to hold on behalf of the minor child and if there was any other provision in the Will for the maintenance of the minor.
It would be possible to avoid the intermediate income trap if the contingent gift was made specific rather than just be a general pecuniary legacy, for example Joe could ear mark where the money is to come from:
“I give my HSBC plc bank account in Winchester to my great niece Louise if she attains the age of 25”
If the gift was made specific in this way it has to be clearly identifiable and therefore separate from the residue of the estate both at the time Joe makes his Will and on his death. This sounds straightforward but Joe may spend the money in the account or an attorney doing the best to manage Joe’s finance’s for him may close the account whilst he is alive and invest the money elsewhere so the gift in the Will could fail. If it is specific then the provisions of s.175(1) Law of Property Act 1925 will apply so that the intermediate income would belong to Louise and not Katy.
A gift left on trust – the whole caboodle?
If Joe said:
“I give £100,000 to my Trustees to invest it in exercise of the powers of investment given to them by this Will and to hold it and the property which currently represents it on trust for my great niece Louise if she reaches the age of 25”
In this example the £100,000 will be properly managed by the trustees; invested to produce income or capital growth as appropriate to her needs and ss.31 and 32 Trustee Act 1925 will apply between Joe’s death and Louise’s 25th birthday.
This means that:
- there will be administrative costs in managing the money
- the trust rate of income tax will apply to any income which is currently 40% but will be 50% on non-dividend income from 6 April 2010 unless it is used for Louise’s benefit or paid to her from the age of 18; in which case the trustees will have to pay the trust rate of income tax and provide a tax certificate to Louise in order to enable her to make a claim for repayment of tax should she not be a higher rate tax payer
- there will be the risk that there will not be £100,000 at the time Louise reaches 25 depending on the choice of investment; the chosen return; the state of the markets and whether money has been advanced to her in the meantime under s.32 Trustee Act 1925.
A gift of a share of residue instead?
If the gift by Joe was in fact a share in the residue so he might say:
“I give a one third share in my residuary estate to my great niece Louise if she attains 25 and the remaining two-thirds share in my residuary estate to my niece Katy absolutely”
Then apart from adding a suitable accruer clause or longstop gift to cover what might happen to Louise’s interest should she not make 25 the contingent gift to her of a part of the residue will automatically carry with it the intermediate income as s.175 (1) Law of Property Act 1925 will apply. The benefits of ss 31 & 32 Trustee Act 1925 will also apply to manage the funds until Louise is 25
Whilst it is highly likely when you talk to Joe he will either want the simple legacy but with the intermediate income or the trust approach what he certainly will not want is a mess if you had simply done what he asked and omitted to discuss the effect of making contingent pecuniary legacies.
© Gill Steel, LawSkills Ltd. 2010
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