Hanging Loose – the climate for IHT planning
What should you advise a client to do? The Government has just announced in the Budget 2010 that the Nil Rate Band (NRB) is frozen at £325,000 until 2014/15. The Conservatives announced some time ago that they intend to raise the NRB threshold to £1 million whilst retaining the transferable NRB (TNRB). Even with the current budget deficit the Conservatives maintain they will adhere to this policy, it might just be delayed.
Meanwhile, we have the Government’s statistics for the amount of money in millions of pounds generated by the various taxes both direct and indirect which shows just how small a contribution to the fiscal pot IHT makes. For 2009/10 it represented 2,251 million which sounds a lot until you hear that Beer duties bring in 3,151 million and it is likely that there are more HMRC staff administering IHT than Beer duty!
If the government’s coffers are definitely half full and considerable public sector retrenchment is ahead whichever political party gains power after the election one does have to wonder why we continue with IHT when a mere 2% on income tax would bring in more at the current time or even 3.5% on VAT.
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For some years clients needed to use both spouses NRBs and therefore we drafted Wills and trusts with this in mind; encouraging clients to ensure that both spouses had at least the NRB in their sole name and depending on the size of their wealth that they either mad life time gifts into trust every seven years or at least made a NRB discretionary trust in their Wills so that no NRB was wasted.
Along came 9 October 2007 and the introduction of the TNRB and with it the desire of most clients of modest means to hold on to their assets preferring to leave their whole estate on the first death to the surviving spouse or civil partner. This leaves the survivor free to use all the joint estate without having to work alongside a set of trustees who may not be willing to do what the survivor wants and enables their own personal representatives to make a claim for a TNRB as well as their own NRB on their death. In other words, for some clients simplicity is best and there is no desire to create trusts.
However, not all clients are so trusting and some will have been married before so it is important still to consider the use of a trust of some kind. We all know that cohabitants are not able to benefit from the TNRB regime so for them there is still the need not to combine the joint estate and potentially end up with the same assets taxed twice – once on the first death and once on the survivor’s death. For this reason we need to consider the use of a trust.
- The use of the NRB of the first to die with an absolute gift of remainder
- The use of the NRB of the first to die with an immediate post death interest over the residue
- The use of the immediate post death interest over the whole estate
The use of the NRB of the first to die with an absolute gift of remainder
Most spouses and civil partners will not want to fix their entitlement to a NRB of only £325,000 when there is the prospect of £1 million ahead. It is likely that instead, unless there are children from a prior marriage which the testator wishes to secure his estate for in the future the testator will prefer to forgo the use of his NRB and rely on the use of the TNRB or the abolition of IHT.
Cohabitants whose estates exceed £325,000 will want to ensure that as little as possible of their joint estates bears IHT more than once. If Andrew and Susan each are worth £325,000 then should Andrew adopt the approach of his married brother and leave the whole of his estate to his partner Susan there would be no IHT to pay on Andrew’s death but potentially £130,000 on the joint estate on his cohabitant Susan’s death. If, however, Andrew created a NRB discretionary trust with Susan as one of the beneficiaries there would still be no charge to IHT on his death but neither would there be on Susan’s death as her estate would not be added to the discretionary trust – each would be taxed independently giving no IHT bill on the second death.
If Andrew and Susan were each worth say £500,000 then limiting the gift to the discretionary trust to simply the NRB when it is frozen at £325,000 would improve the position but not reduce it as much as not limiting the gift to the discretionary trust at all. If Susan was to die first and leave all her estate in a discretionary trust with Andrew as one of the beneficiaries there would be tax to pay on her death if we are still limited to a NRB of £325,000 – £70,000; but after tax the remaining £430,000 of her estate would not be coupled with Andrew’s estate which would itself be taxable on his death at the same rate of £70,000 but only if the NRB has not been changed by then or IHT not abolished.
If Susan left only the NRB in discretionary trust and the balance to Andrew outright, then, after IHT, Andrew would receive £105,000 from Susan’s estate. On Andrew’s death the IHT bill would then be £112,000; making the total IHT payable across the two estates £182,000 instead of the £140,000 when the whole of the first partner’s estate was left to a discretionary trust.
The use of the NRB of the first to die with an immediate post death interest over the residue
The similar considerations apply here as for the first scenario save that if a trust is used for the NRB gift and the residue is held in IPDI trust the surviving spouse receives nothing outright from the testator and may feel inclined to make an Inheritance (Provision for Family & Dependents) Act 1975 claim.
Also, for the cohabitants there is the added spice of the two trusts being related settlements as the s.80 IHTA 1984 relief for spouses does not apply.
The use of the immediate post death interest over the whole estate
This option does have the benefit of keeping everything fluid for tax purposes whilst imposing some control for succession purposes over the estate.
With an IPDI gift between spouse or civil partners the s.18 IHTA 1984 exemption will apply. For cohabitants since there is no mention of the NRB then there is no worry about its increase or decrease however, it does not bring with it any exemption under s.18 therefore there is still the prospect of double taxation to the extent that anything over the NRB on the first death will be immediately chargeable and all the joint estate will be taxable on the second death because of the application of s.49(1) IHTA 1984.
The moral of these stories is to keep things as flexible as possible in uncertain times by making all gifts to spouses either outright gifts or into fully flexible IPDI trusts with good overriding powers which will enable the trustees to act as appropriate to reflect the existence or otherwise of a NRB or indeed IHT. In the case of cohabitants, despite the fact that there may be some IHT to pay on the first death (and how this is to be met will need to be discussed) it would probably be equally flexible if all the estate on the first death was left to a discretionary trust. Again, this will leave the trustees with full opportunity to take the right decisions in the light of the tax regime applicable at the date of death.
As has been said one hundred times before ‘Nothing is certain except Death and Taxes’ it is just that before an election it is anyone’s guess as to quite what those taxes on death might look like. Hang loose, hang loose.
It is this political uncertainty which is surely keeping clients from undertaking tax planning at the current time coupled with their need to retain as much capital as possible to fund their future in a low interest world. How do we suggest clients should approach Will drafting and estate planning against this backdrop?
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