Variation of Wills and other Post-Death Arrangements The function of a will is to ensure that the testator s property, on hand at death, passes to the chosen beneficiaries, whether absolutely or in trust. A will also enables the appointment of executors as those who will administer the estate. And of course it makes sense for a will to be inheritance tax (IHT) efficient, as far as possible. The Ideal plan your estate Everyone over 18 who owns, or perhaps has the prospect of owning, sufficiently substantial assets should have a professionally drawn will. The will and any other documents relating to death should be kept under review, certainly every five years and perhaps more frequently than that in the event of significant changes in either family circumstances or on the introduction of new legislation. Of course, it is well known that, for whatever reason, a significant proportion of the population does not currently have a will. What might be less well known is that not all wills, even where professionally drawn, necessarily maximise the IHT efficiency open to them and in some cases can lead to litigation in the Courts. The purpose of this Briefing is to highlight the possibilities for making what might generally be called post-death re-arrangements in respect of wills (or indeed the lack of them) within two years after death, in a way which will enhance the IHT efficiency of the testator s financial affairs. It is also possible for an adult to vary the statutory effect of an intestacy (see below) just as much as a will. BRIEFING We should say also that while such variations are usually effected for IHT reasons, they can be used also to resolve a defect in a will, for example an ambiguity in the language or a significant typographical error. Among a number of options, there are four principal ones, under the Inheritance Tax Act 1984 ( IHTA 1984 ), as follows: a) Written variations of a will or intestacy (section 142 IHTA 1984); b) Disclaimers (section 142 IHTA 1984, again); c) Precatory trusts (section 143 IHTA 1984); and d) Appointments out of discretionary will trusts (section 144 IHTA 1984); and Less than ideal Intestacy : How is property distributed where there is no will? The order of distribution is laid down in the Administration of Estates Act 1925 as follows: Where there is a surviving spouse/civil partner a) if the deceased leaves no children, parents, brothers or sisters or their issue, the spouse/civil partner takes the whole of the estate; Page 1 of 8
b) if there are children surviving: The spouse/civil partner will take personal chattels, a statutory legacy of 250,000 and a life interest in half of the residue (if any); and The children (or their issue) share the other half of the residue and also take the surviving spouse s (civil partner s) share on his or her death; c) If there are no children but one or more of parents, brothers and sisters and their issue survive: The spouse/civil partner will take personal chattels, a statutory legacy of 450,000 and half the residue (if any) absolutely; and The other half is shared by the parent(s) absolutely or, if neither survives, the brothers and sisters (or their issue) absolutely. No surviving spouse/civil partner a) Any children (or their issue) will take the whole estate absolutely; b) In the absence of children or remoter issue, the whole estate goes to the other surviving relatives in a specified order of preference or, failing that, the Crown. The specified order is parents; brothers and sisters (or their issue); half-brothers and sisters (or their issue); grandparents; uncles and aunts (or their issue); and parents half-brothers and sisters (or their issue). IHT Efficiency This means making appropriate use of the exemption for gifts to a surviving spouse or civil partner. (If the deceased is UK domiciled for all IHT purposes and the surviving spouse or civil partner is not, that exemption is limited to 55,000 on a lifetime basis. It is worth noting that, where the survivor is resident or domiciled in a Member State of the European Union, that limitation is likely to be repealed, though this might take some years.) The traditional wisdom (at least prior to 9 October 2007) was on the first death of a married couple/civil partnership for full use to be made of the available nil-rate band or NRB ( 325,000 for 2010/11 and indeed through to 2014/15) and then for the balance to go to the survivor, whether absolutely or in trust. The survivor could then, if sufficiently well provided for, make potentially exempt transfers (PETs) to say the children, hoping to survive for seven years thus making those onward gifts IHT exempt. While that wisdom remains insofar as PETs are concerned, the overall policy has been somewhat qualified by the introduction of the transferable nilrate band (TNRB) : this means that, on the second death on or after 9 October 2007, any unused percentage of the nil-rate band (NRB) remaining from the first death (whenever that took place and based on the NRB in force at that time) can, up to a maximum of 100%, be applied by way of addition to the NRB available on the second death. Page 2 of 8
Examples 1 Jack died in 1998 leaving his entire estate to his wife Jill. Jill died on 1 July 2010 when the NRB is 325,000. Providing a claim is made within two years after her death, the NRB in Jill s estate is 325,000 x 2 = 650,000. Caroline died on 1 January 2009 leaving 156,000 equally to her three children and the rest of her estate to her husband David, so using 50% of her NRB (in 2008/09). If when David dies, the NRB has increased to say 1 million, the NRB in his estate can, on a claim, be increased by 50% to 1.5 million. This is not the place to go into the intricacies of the TNRB, though the possibility of taking advantage of it in a case where the will does not, is very germane to post-death re-arrangements. Suffice it to say: a) A strategy of having the whole estate go to the surviving spouse or civil partner on the first death can bring advantages in terms of simplicity b) There could be significant IHT advantages in the event of a substantial rise in the nil-rate band between the two deaths (eg, in the event of the introduction of a nil-rate band of 1m as the Conservative Opposition was proposing last year, though now, in present circumstances, merely a distant memory). Written Variations of the Estate What used to be called deeds of family arrangement (limited by the fact that benefits could be passed only to defined family members) are now broadly known as written variations. While in practice they will be made by deed (requiring execution in front of a witness and formal delivery ), they need simply be in writing. In its simplest form, the beneficiary of a gift under the Will or of a share in residue will simply direct it to someone else. However, there are antiavoidance provisions which need to be watched, as discussed below. Section 142 provides that for all IHT purposes a written variation made within two years after the death will have the effect of substituting the terms of the variation for those of the will, with no gift made by the original beneficiary in favour of the new beneficiary. Generally, note that to make a variation the beneficiary should be aged at least 18. Example 2 Ann has just died, her husband Bertie and her 30 year old son Charles surviving her. Ann s will leaves 500,000 to Charles, subject to paying tax and the remainder of her estate (the residue ) to Bertie. Ann had made no chargeable gifts in the seven years before she died (which would have reduced her available nil-rate band of 325,000). So 175,000 of the gift is chargeable at 40% producing IHT payable of 70,000. Charles could within two years of his mother s death reduce his legacy Page 3 of 8
to 325,000 increasing the spouse exempt residue by 175,000 and therefore his father s inheritance by that amount. But, as explained below, this should not be done in conjunction or expectation of a simple cheque for 175,000 written by father to son the consideration trap. In this simple case, only Charles needs to sign the document, though in practice, it would be sensible for both the executors and indeed Bertie (who is likely to be one of the executors) also to sign. There is no requirement for the variation to be produced to Her Majesty s Revenue & Customs (HMRC) within six months of execution as there used to be. In practice of course the solicitors dealing with Ann s estate will be producing the variation to HMRC to evidence the IHT analysis of the will. All that is necessary is that the variation contains a statement that section 142(1) of the Inheritance Tax Act 1984 is intended to apply to the variation. There is a small point for Capital Gains Tax (CGT) purposes: inclusion in the variation of a reference to the CGT legislation (Taxation of Chargeable Gains Act 1992 section 62(7)) prevents the variation from being a disposal. This might be relevant if the variation covered a chargeable asset such as land and the value of the land had increased between the date of the death and the date of the variation. Variations: The Traps 1. The consideration trap Example 2 above illustrates a fairly straightforward and indeed obvious use of variations. However, the variation will be ineffective if it is made for consideration, that is there is any agreement that the new beneficiary will reimburse - or indeed make any payment at all to - the original beneficiary and there are no pro-rata or de minimis limitations to the rule. In a case such as this, HMRC Trusts & Estates (as HMRC Inheritance Tax have recently been rebranded) traditionally write a letter to the solicitors asking two questions: a) Before the variation was signed, was the possibility discussed with the family that the surviving spouse might make good a gift to the original beneficiary? This is often hard to answer in the negative; and b) Whether the survivor has indeed done so or plans to do so, which one does need to be able to answer (with honesty) in the negative. Certainly if there is to be any element of onwards gift, this should occur sometime later, certainly after HMRC clearance has been obtained, ideally of a different amount and perhaps to a different donee, eg to the children of the original beneficiary and certainly then with the benefit of independent advice, perhaps to enhance the original beneficiary s own IHT situation. Page 4 of 8
That this trap is a point taken by HMRC can be seen from a 2009 Special Commissioner s case called Lau where the Court rejected an argument that the very sizeable gift made by the surviving spouse to the original beneficiary (following a variation by him in her favour) had been with a view both to provide a marriage gift and to set him up in business. 2. The Income Tax trap The IHT and limited CGT deemings of a variation are not carried over to Income Tax. Here one has to consider the anti-avoidance settlement provisions under the Income Tax regime, whereby: a) If a settlement (which is defined very broadly) includes among its beneficiaries either the settlor (the person making it) or his/her spouse/civil partner, the income will be treated as that of the settlor; and b) If the settlor s minor children who are unmarried or not in a civil partnership of the settlor can benefit again the income (whether or not paid out) will be assessed on the parent s settlor. For purposes of (b), though not for (a), settlement would include an outright gift. So this is a point to be borne in mind with variations, also. 3. The short-term interest in possession trap The third trap arises where the variation creates a qualifying interest in possession which lasts for less than two years from the death. This represents what might be called the other side of the coin of the consideration point illustrated by Example 2. If Charles had, say 6 months after his death, created what is called an immediate interest in possession (IPDI) in favour of Bertie and the trustees had exercised their powers to bring that interest to an end in favour of Bertie say after a further six months, the variation would be treated as ineffective from the beginning. HMRC are known to take the point, on the basis that the action of the trustees is completing the variation made by the original beneficiary. If the new beneficiary dies within the two year period, however, that will not trigger the trap. The Gift Aid Ruse An ingenious beneficiary might wish to take advantage of the fact that there are no deeming provisions for Income Tax. Suppose that he is more charitably minded than his late father and wishes to give perhaps both 20,000 of his inheritance to a charity. Obviously, in IHT terms, that will save up to 20,000 at 40%. But there is also now the additional benefit of getting to the charity 20% of the gross amount plus the further 3.2% of the net transitional relief (in 2010/11) not to mention higher and additional rate relief of a further 30% of the gross gift for the beneficiary assuming that he is a 50% taxpayer. The 20,000 gift to the charity would be grossed up by 20% to 25,000 and the 50% taxpaying beneficiary would get tax relief at 30% of the gross payment amounting to 7,500. So it would cost just 12,500 to give to the charity 25,640 (including the 3.2% supplement in 2010/11). Page 5 of 8
However, Gift Aid relief is not available where the gift brings a benefit to the donor, subject to some de minimis exceptions. A Special Commissioner decided in 1997 in a case called St Dunstan s v Major that the IHT saving for a beneficiary of residue was such a benefit, so denying Gift Aid relief for Income Tax. This principle has been followed this summer in a case called Harris. It should be possible to argue that the St Dunstan s decision does not apply (a) where a beneficiary is varying part of a legacy, so that the IHT benefit goes not to him but to residue; or (b) where the beneficiary of residue who makes the charitable gift expressly alienates the IHT saving, by making a further gift of that amount to the charity. A Practical Illustration: Passing on Growth IHT-free Suppose that either the value of the whole estate or perhaps that of one or two specific assets, increases markedly in the two years following death. It could be sensible to have that increase go to chargeable rather than to exempt beneficiaries. The magic in the suggestion is that, by using an appropriately drawn variation, it is the value at the date of death and not the value at the date of the deed which is treated as passing under the will for the new chargeable beneficiary. The beneficiary s acquisition cost similarly for CGT purposes will be the value at the date of death, so preserving the inherent gain in the beneficiary s hands but assuming that the relative CGT statement is made in the variation occasioning no CGT event at that stage. Example 3 David died on 1 September 2009 with an estate of 1m, all of which is left to his wife Edwina. Twelve months after his death the value of the estate has increased to 1.5m, all of which is attributable to listed shares worth 325,000 at David s death. Edwina could, before 1 September 2011, make a deed of variation creating a specific gift of those shares to her children. Supposing that David had made chargeable transfers of 325,000 in the seven years before he died so using his nil-rate band. Edwina s deed of variation could have her take a legacy of 1m with residue to the children. The IHT legislation would attribute the whole of the estate for IHT purposes for the exempt specific gift, so passing the 500,000 appreciation free of IHT to the children. Disclaimers A beneficiary under a will does not have to accept the gift. It can be disclaimed by a written document in the same way as a variation, under section 142, again with no gift made by the original beneficiary. However, there are two significant differences from variations: a) The disclaimer cannot direct property to a specific individual : the will is simply read as if the person making the disclaimer had died; and Page 6 of 8
b) A disclaimer will be rendered ineffective should the beneficiary have taken any benefit from the asset(s) concerned since the date of death. So a disclaimer is really appropriate in only very straightforward cases and generally a variation will be preferable. Precatory Trusts the NRB trap This may seem rather a technical term, though it is a well established one. It refers to the facility offered by section 143 for the testator to express a wish, usually in a stand-alone document left with his will, that the original beneficiary of an asset should within two years after his death pass it to someone else. If in accordance with that wish the beneficiary does so, then for IHT purposes the ultimate donee is written into the will as the beneficiary. Typically, this provision is used with personal chattels and, as with discretionary trust appointments discussed below, the will is written on the basis that section will be used. The letter can be amended and updated from time to time by the testator without the need to refer back to the solicitors who drew up the will. For example, therefore, there could be an exempt gift of all the testator s personal chattels to his widow, coupled with the wish that she gives effect to the terms of any memorandum of wishes left with the testator s papers at his death within two years after his death. The letter allocates particular possessions to particular members of the family, the widow duly distributes them in accordance with it and this writes chargeable gifts back into the will for IHT purposes. In the context of the TRNB this might not be a good idea and there could be another way of achieving the same object, eg by having an IPDI for the widow with power for the executors/trustees to make the transfers of chattels, so causing the widow to make a PET, thus preserving her husband s NRB. Discretionary Will Trusts: Post-Death Appointments Section 144 provides a useful facility in the case of a discretionary will trust, which may extend to the whole or just part of the estate (eg, limited to the NRB). An appointment by the trustees once at least 3 months have elapsed since the date of death will have the effect that the terms of the appointment are read back into the will, whether this is in favour of for example a surviving spouse or charity or indeed children/grandchildren or trustees for them. The important consequence is that the special IHT regime which applies to discretionary trusts (with its system of exit charges) is disapplied automatically from the period running from the death to the date of the appointment. And so, if for example, the appointment simply redirected the whole of the assets in the estate back to the surviving spouse, the spouse exemption would apply on death in the normal way. Typically, the will would be drawn with a view to using this facility, on the footing that the testator was not entirely sure at the date of making the will how the assets should devolve on death. It is important in such a case that he leaves very clear wishes as to how the trustees should act. Page 7 of 8
There is no CGT relief for a section 144 appointment, so there could be CGT for the trustees to pay at 28% (after the annual exempt amount of 5,010 in 2010/11) if the assets have enjoyed a significant increase in value since the date of death. However, it is possible to avoid this problem by a device accepted by HMRC. That is, one ensures that the appointment is made before such time as the executors have passed the assets concerned to the trustees: this is on the analysis that the trustees do not at the time of the appointment hold a chargeable asset of which they can dispose. Conclusion We are bound to restate The Ideal expressed at the beginning of this Briefing. But the ideal world is prone not to happen. And, happily, the options afforded for IHT mitigation by sections 142, 143 and 144 are very useful. However, as with all tax planning there may be complications, not least in relation to the anti-avoidance rules discussed in relation to variations. So, as ever, professional advice is essential. For further information, please contact Hugh MacDougald, Head of the Private Client Department: Hugh MacDougald DT: 020 7593 5149 E: hmacdougald@wslaw.co.uk Page 8 of 8