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Tax Doctor:
Anthony Nixon
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June 2005
Q:
I understand that in most cases properties are held as tenancies in common to take advantage of the nil rate band of £263k. However when the assets involved are considerable (several millions), to ensure a smooth and most tax-efficient transfer from husband to wife, should this still be the case or should the majority of assets (properties) be held as joint tenancies?
A:
In these circumstances there is all the more reason for holding properties as tenants in common provided you also get your wills in the right form. This can enable all the assets of the first spouse to die to be free of IHT.
For most married couples the best way of planning for inheritance tax (IHT) is through their Wills.
A “nil rate band discretionary trust” can save up to £110,000 IHT (40% of the nil rate band which has now increased to £275,000) with an example similar to the following. This article shows how a second trust can save still more.
Example 1 – discretionary trust
Peter and Fiona Green own, in equal shares, a home worth £650,000, investments worth £250,000 and building society accounts totalling £100,000.
By his Will, Peter leaves the first £275,000 worth of his assets to a discretionary trust, and any surplus to Fiona.
There is no IHT on Peter's death.
Fiona can benefit from the discretionary trust during her lifetime but the £275,000 is free of IHT when Fiona dies. IHT on Fiona's estate is £180,000. (£725,000 worth of assets is taxed. The first £275,000 is free of tax and £450,000 is taxable at 40%).
Had Peter's Will not included the trust, IHT on Sarah's death would have been £290,000. |
But IHT on Fiona's death is still £180,000. The solution is for Peter to include two trusts in his Will:
- The same discretionary trust of the first £275,000.
- A second flexible trust, which replaces the gift to Fiona of the rest of Peter's assets. Fiona is initially entitled to the income from these assets.
This arrangement allows all Peter's assets to be available for Fiona but to escape IHT on Fiona's death.
Fiona's initial right to the income of the second trust means that, for the purposes of IHT, she is treated as its owner. There is no IHT to pay on Peter's death.
Soon after Peter's death, the trustees of Peter's Will use a power included in the Will to bring to an end Fiona's right to income. This is done in a way that ensures there is no immediate IHT charge. Although she no longer has the right to the income, Fiona can still benefit from the second trust.
At the point Fiona's right to income from the second trust ends she ceases to own it for IHT. But she has not made a gift. The trustees have exercised a power in Peter's Will. There is no reservation of benefit. Nor does the tax charge on “pre-owned assets” have any impact.
If Fiona lives more than seven years after her right to income ends all Peter's assets will be free of IHT. If she lives at least three years there may be some saving as the rate of IHT begins to taper.
The trusts that continue after Fiona's right to income has ended remain entirely flexible. The form of those trusts depends on the circumstances at the time. Sometimes those trusts will be entirely discretionary, like the first trust; in other circumstances children, or even grandchildren, may be given a right to income, perhaps for a limited period.
Example 2 – two trusts
Peter's Will includes both trusts. Assets worth £275,000 pass to the first (discretionary) trust. Fiona has the right to the income from Peter's remaining assets (£225,000) which go to the second trust.
There is no IHT to pay on Peter's death. The gift to the discretionary trust is of the tax-free £275,000. There is no IHT between husband and wife so the remaining £225,000 is also free of IHT.
Soon after Peter's death the trustees end Fiona's right to the income of the second trust.
Fiona dies eight years later. There is no IHT on any of Peter's half of the assets.
If Fiona still owns all her half of the assets, IHT on her death is £90,000 (£500,000 is taxed. £275,000 is free of IHT and there is 40% IHT on £225,000).
The saving is now £200,000. |
The fact that Fiona still has access to all Peter's assets may enable her to make gifts out of her own assets from which she can afford to be excluded. This can further reduce the IHT on Fiona's death.
At the time they make their Wills Peter and Fiona will not know which of them will die first, so both their Wills should include the same trust arrangements.
If the assets of the second trust are worth more than £275,000 care has to be taken when ending the surviving spouse's right to income to ensure that no immediate IHT is payable. In these circumstances, significant IHT savings start to accrue after just three years.
Of course there will not be necessarily be a gap between the date the two spouses die which is long enough for this arrangement to be effective. But many widows and widowers live for many years and the potential tax savings with wills in this form are immense.
About the Author
Anthony Nixon is a partner in South Coast law firm Lester Aldridge. As well as being a solicitor he is a member of the Chartered Institute of Taxation, the Association of Taxation Technicians and the Society of Trust and Estate Practitioners. Anthony specialises in tax planning for private clients, particularly inheritance tax and capital gains tax, and in the law of wills and trusts. He is a well known and popular lecturer on all these subjects. Anthony can be contacted via his Bornemouth or Southampton office.
Anthony Nixon
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