Worried about your family after you have gone?
Have you made a Will? No? Well, you're not alone. Over 60% of us haven't. There are all sorts of reasons people find for not making a Will: they don't have time, or they believe it isn't necessary. Of course none of us plan on dying in the near future and it isn't particularly something that you like to think about either, but making a Will is definitely necessary - you must make time to sort it out, and sort it out properly.
Why is it necessary?
Married couples often assume that it doesn't matter if they do not make a Will because if one of them dies, everything will pass to the survivor. However the intestacy rules, which apply if you die without making a Will, do not achieve this. If a married person (say, the husband) dies, any assets he owns in joint names with anyone else pass to that joint owner. Of any assets in his sole name, only his personal possessions and the first £125,000 of everything else pass to his wife. Anything over and above that is divided into two halves. One half is held in trust and income from the trust is paid to his wife during her lifetime. After her death the capital passes to their children. The other half passes to the children outright once they reach 18.
If the couple do not have children, the wife will receive £200,000 and half of everything over and above that. The other half passes to the husband's blood relatives, such as his parents or brothers and sisters.
It is easy to see how this can have disastrous consequences for the family. Firstly, the wife may be left with too few assets to live on. Secondly, the children will inherit their share of their parents' estates at age 18, which many people consider to be too young. Finally, if an estate is distributed like this, it could have unfortunate inheritance tax effects.
I'm ok - I already have a Will
A good start, but the next question you need to ask yourself, is whether it is an inheritance tax efficient Will? If not, you could be committing your loved ones to paying a much bigger tax bill on your death than is necessary.
To understand why, we need to think about inheritance tax. It is calculated as follows:
Every person has a 'nil rate band'. This is the maximum value of assets that you can leave upon your death without inheritance tax becoming payable. At the moment, the nil rate band stands at £263,000. This means that if you died and left an estate worth £273,000, the first £263,000 would be tax free, and inheritance tax would be charged on the £10,000 excess.
In addition, there are various exemptions, the most important of which states that if assets are passed to your spouse they are free from inheritance tax.
Any assets that are subject to tax are charged at a rate of 40%.
But what does this mean?
The best way to understand all this is by using an example. Consider the case of Bob and Jill. They are married and have two children, Adam, who is 17 and a bit of a tearaway and Becky, who is 21. Bob and Jill have a house in their joint names, worth £300,000. Jill has savings of £50,000. Bob retired recently and received his pension lump sum, which along with his other savings, gives him cash of £300,000.
Unfortunately, Bob becomes very ill suddenly and dies. There are various scenarios that could happen:
1. They don't have Wills. Bob's estate is therefore distributed according to the intestacy rules. Under those rules, Jill takes the house because it is in their joint names. Cash of £300,000 is in Bob's sole name. Of this, the first £125,000 passes to Jill. The remaining £175,000 is divided into two halves. One half, (£87,500) passes into a trust for Jill. The income is paid to her for the rest of her lifetime, and upon her death the capital will be divided equally between Adam and Becky.
However, the other half is again divided into two halves, each of £43,750. Becky takes her half immediately, because she is over 18. Adam has to wait a few more months, until he is 18. He isn't able to handle money very well and has spent it all before his 20th birthday.
There is no inheritance tax to pay because all the assets passing directly to Jill or into trust for her are exempt from inheritance tax. The only asset that would be taxable is the £87,500 passing to the children. This falls within Bob's nil rate band of £263,000.
Although Jill has taken the house and some cash from Bob's estate, the income produced by holding the £87,500 in trust isn't very much and she soon starts to run short of money. She eventually has to sell the home and move somewhere smaller.
2. They have made Wills leaving everything to the surviving partner. On the death of the survivor, everything is divided between Adam and Becky when they reach the age of 25.
When Bob dies, everything passes to Jill. There is no inheritance tax to pay because all the assets passing to Jill are exempt from tax and there is nothing passing to anyone else.
6 months later Jill dies. At that time, she has the cash of £300,000 that Bob left her, together with the house worth £300,000 and her own savings of £50,000. This gives her a total estate of £650,000.
There are no exemptions from tax to be used because everything passes to Adam and Becky. The nil rate band is deducted first, leaving Jill with a taxable estate of £387,000 (£650,000 - £263,000). Inheritance tax is paid at the rate of 40%, so in total inheritance tax of £154,800 is due.
Whilst this scenario is better because it gives Jill access to all of the cash within Bob's estate (and protects Adam until he reaches 25), the downside is the inheritance tax that is eventually due.
3. They have made inheritance tax efficient Wills. This is done by making the most of Bob's nil rate band - it was wasted in example 2 above because Bob left all of his assets to Jill. Their Wills could instead have stipulated that on Bob's death a trust would be created to hold assets to the value of his nil rate band. This trust is known as a discretionary trust.
The trust has a wide class of beneficiaries, which would include Jill, Adam, Becky and any future grandchildren. The trustees of the trust could be Jill and Becky, and also Adam once he reaches the age of 18. No beneficiary has a right to take either income or capital from the trust fund, it is left completely up to the discretion of the trustees as to who takes what. As a result, the assets in the trust do not form part of any beneficiary's estate for inheritance tax purposes upon their death.
The Will goes on to state that any assets Bob owns over and above the nil rate band pass to Jill outright, to ensure that the surviving spouse exemption from inheritance tax is available on all of Bob's other assets.
When Bob dies, the first £285,000 cash in his estate (the amount equal to the nil rate band) passes into the discretionary trust. The rest of his savings (£37,000) pass to Jill and are exempt from tax. The house passes to Jill automatically and is also exempt from inheritance tax.
Jill and Becky, as trustees of the discretionary trust, agree that it is their priority to use the cash in the trust fund to provide for Jill during her lifetime, so it is invested and most of the income is paid out to Jill.
When Jill dies 6 months later, the assets in her estate are: the house worth £300,000, the cash of £37,000 she got from Bob's estate and her £50,000 savings. This totals £387,000. Jill has a nil rate band of £263,000, leaving £124,000 upon which inheritance tax is payable at 40%. This gives a total tax bill of £49,600. This is a saving of £105,200 compared to example 2.
Make yourself tax efficient
Wills are just one of the ways to save tax. Other tax tips can include:
You are an unmarried couple
Everything you leave your Partner over £263,000 will be subject to 40% inheritance tax when you die. In addition, they will have to pay tax on those assets again when they die. You could instead leave assets to them using a trust structure, which prevents that double charge to tax.
You have business or agricultural assets
Business or agricultural assets may be free from inheritance tax upon your death. However, what happens if they are sold after you die? The cash sale proceeds will be taxable within your spouse's estate upon their death. With specialist advice you can draw up your Will so as to protect the sale proceeds from that tax charge.
You have pension or life assurance policies
These may all pay out lump sums upon death but are often forgotten when planning the distribution of your estate. By writing them into trust you can stop them from falling into your, or your spouse's, taxable estate.
You have a holiday home or a second property
Think about giving it away into trust for the next generation. You can still use it, providing you pay rent when you do so. However, you will no longer be responsible for all the running costs of the property - these will be paid by the trust instead.
You have large amounts of excess income
You could give away your home to a trust and rent it back. This allows you to remove your home from your estate for inheritance tax, plus all you pay in rent. Your ability to live in the home is protected by the rental agreement.
You are thinking of moving offshore
It is possible, but to avoid a charge to inheritance tax in the UK involves a lot more than moving abroad - you have to lose your UK domicile. This means that you need to sever all ties with the UK. Get advice before you go to make sure you are doing everything you can to alter your domicile.
Make that important move. Get advice and give yourself peace of mind that everything will be in order after you have gone.
This is intended as a brief guide only. For comprehensive advice on Wills, Trusts, Tax Planning and Probate please complete the online enquiry form.
Please note, that the information here relating to Pensions, Life Assurance and Trusts will be affected by the Finance Bill, which is shortly due to be published.
The information contained here in this guide is correct as of July 2006.
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