Will planning to mitigate tax and avoid post-death disputes

More statistics - more reasons to advise clients to make a will

According to the research commissioned by the Law Society in late June 2020, and published on 2 December 2020, only 41% of those surveyed said they did have a will, including 7% of respondents who made or updated their will during the first UK-wide COVID-19 lockdown. Think of it as possibly the only positive aspect of the pandemic. That still leaves an awful lot of people without a will.

The main reasons respondents gave for not making a will were not having anything of value to leave to their loved ones (24%), not finding the time to make a will (20%) and thinking they were too young to make a will (18%). All of which may, in fact, be a substitute for "I don't want to think about dying" and therefore an objection that any financial adviser should be able to overcome. Even if you don't care what problems this (not having a will) could cause for those you leave behind after your untimely death (it won't be your own problem after all),  think about the time and money that will have to be spent to sort out the estate of your granny or your parents or your aunt or your siblings if they die without a will... (NB 68% of those surveyed also did not make lasting powers of attorney, but that's a matter for another article).

Video-witnessed wills – a simplification or a complication?

Another topical issue of late is the new method of will execution, namely the video witnessing of wills. The most recent person to wade into the argument was John Stevenson MP, who is also a solicitor and who recently declared that in his opinion "video-witnessed wills are unnecessary and risky for firms”, that they “open up the opportunity for undue influence” and “could place solicitors at risk of disciplinary action” and that his own practice “wouldn’t touch it."

As outlined in previous articles, while in England the Wills Act 1837  originally required two witnesses to be in the physical presence of the testator, the statutory instrument which came into force at the end of September 2020 allows testators' signatures to be witnessed using video conferencing software, such as Zoom, Facetime and Skype, at least until 31 January 2022.

Mr Stevenson is not the only one opposed to the new process although, admittedly, many practitioners oppose it for different reasons. For a start, it is important to remember that it is only the witnessing that can be done via a video-link and this alone will not suffice to make a valid will. The process is, in fact, quite complicated, the video witnessing being only a part of the process. Far from simplifying the issue, the need to subsequently post the will to each witness (who then needs to sign in wet ink and with a video link to the testator) and back to the testator (resulting in what has been referred to as a "well-travelled will") does not only pose practical problems, such as the possibility of the will getting lost in the post or the process not completing before the testator dies, there are security and confidentiality issues. With a normal physical witnessing, the witness only sees the last page of the will; under the new process, the entire will is passed from one person to another. Many people will not be happy with this. So, while the new process has some support, it remains to be seen just how popular it will be. The Law Society advises that video witnessing should be used as a last resort.

Tax considerations

Tax considerations are often paramount in will planning, and to ensure that a will is tax-efficient it is important to appreciate some fundamental tax points. This month we will consider the interaction of lifetime planning and the availability of the residence nil rate band (RNRB).

The first important issue is how to ensure that the RNRB is available. If it is available this may result (coupled with the standard and transferable nil rate bands) in assets of up to potentially £1M passing down to the next generation free of tax.

• The RNRB will only be available when a qualifying residential interest (broadly, an interest in property that has at some time during the period of ownership been occupied by the deceased as a residence - so no investment property) is 'closely inherited' (that is, inherited by lineal descendants or their spouses/civil partners). So, the RNRB is only ever available on death (unlike the standard NRB which is available to lifetime gifts as well).

• For the purpose of the RNRB it does not matter whether the property is the "main" or "principal" residence - this is only relevant for capital gains tax (CGT) purposes. For inheritance tax (IHT) purposes what matters is whether the property has ever been the testator’s actual residence.

• The RNRB is still available where an individual either downsized or ceased to have a residence at all (if, for example, they have moved into residential care). This additional amount of RNRB is known as the ‘downsizing addition’. Note that the property may have been sold or may have been gifted, it does not matter which. Records of the transaction should be kept.

• The amount of the downsizing addition will usually be the same as the additional threshold that has been lost when the former home is no longer in the estate. The estate’s personal representatives must make a claim for the downsizing addition within two years of the end of the month in which the person dies. 

• Although the RNRB applies to deaths occurring after 5 April 2017, the downsizing provisions apply to disposals of property on or after 8 July 2015.

• Lineal descendants include children, grandchildren and remoter issue, adopted children, stepchildren and foster children.

The RNRB started at £100,000 in tax year 2017/18 and gradually increased to £175,000 for tax year 2020/21. Where the value of the estate (after deducting liabilities but before reliefs and exemptions) exceeds £2 million then, broadly, the RNRB will be reduced by £1 for every £2 of excess value so that in 2020/21 there will be no RNRB available on first death if the net value of the deceased's estate exceeds £2.35 million. For the purpose of the £2M limit, all assets in the estate at the time of death count without applying reliefs, such as business relief. However, gifts made in the 7 years before death are not relevant so that a gift of £1M (or whatever) on a deathbed could bring back the RNRB if it reduces the estate to the £2M limit. Of course, such gifts, unless exempt, will reduce the availability of the ordinary NRB if made within 7 years of death.

The above is particularly relevant if large gifts to charity are contemplated. If made before death, they will reduce the value of the estate for the purposes of the RNRB. If they are made in a will, they will not.

• Any unused RNRB is transferable to a spouse in the same way as the standard NRB and will apply on the second death even where the first death occurred before 6 April 2017.

• If the property has been gifted, but is subject to a reservation of benefit (and so treated as being in the estate of the donor), the RNRB will be available provided the donee qualifies as a lineal descendant.

It is important to note that the RNRB is not set against the legacy of the residential property but applies generally to the charge on the estate (ie. it is not focused on the property so that there may still be a tax charge on it). However, the value of the property must be not less than the RNRB.

When is the RNRB not available?

The RNRB is not available to the following:

• People without children. For instance, two sisters living together and the property is inherited by the survivor - no RNRB.

• People who rent a property and have chosen to invest their money, for example in an investment portfolio or let properties.

• When the property does not pass as a specific legacy or via the residue to the lineal descendants.

It is particularly important to remember the last point when drafting a will for an unmarried individual with children where the RNRB may be lost by poor drafting. Imagine, for example, Mr X leaves a home worth £300,000 and liquid assets worth £200,000. He leaves cash legacies of £150,000 to each of his two children and the residue to his long-term (but unmarried) partner. In such a case, as the property does not pass to the children, the RNRB would not be available. If only one nil rate band were available (ie. no transferable nil rate band) this would result in an IHT liability. If, instead, the property was left to the children directly, the RNRB would be available and, assuming the full NRB was available,  the IHT bill would be nil.

 Which will trusts will allow the RNRB to apply?

Where will trusts are concerned, the RNRB will only be available in the following situations:

• a bare trust for a lineal descendant (or their spouse/civil partner)

• an IPDI (immediate post-death interest) trust for a lineal descendant (or their spouse/civil partner)

• a disabled person's trust for a lineal descendant (or their spouse/civil partner)

• an 18-to-25 trust

• a bereaved minor’s trust (BMT).

Clearly, for those who wish to maximise the use of the RNRB, it is important that the will provisions ensure that the relevant legacies qualify and the scope is clearly limited. For example, if the property is left to a discretionary trust, the RNRB will not be available, even if the only beneficiaries of the trust are the testator’s children.

A typical grandparental settlement, ‘to such of my grandchildren as shall attain age 21’, will also not qualify if the grandchildren are minors at the date of the testator’s death because it is a relevant property trust. To secure the RNRB the grandparents would need to opt for a bare trust or at least an IPDI trust. Remember that 18-to-25 trusts and BMTs can only be created by parents.

What about existing interests in trusts?

An individual may have a life interest in a trust they created during lifetime or may be a life tenant under a trust created on another person’s death. Where such a trust holds the life tenant’s residence, will the RNRB apply?

Lifetime “probate trusts”

Prior to 2006, the so-called probate trusts used to be popular. The settlor would transfer property to a trust in which he had a life interest. This would have been a tax neutral transaction for IHT purposes as no value would have left the settlor’s estate. The property simply remained in his estate for IHT purposes (but was outside the estate for probate purposes). Where such a trust still exists then, as long as the remainderman (the person inheriting the property on the death of the life tenant) takes absolutely, the RNRB would be available.

If a similar trust were created after 22 March 2006, this would have been a chargeable lifetime transfer for IHT purposes,  and also a gift with reservation of benefit. For this reason, such trusts are no longer popular except, perhaps, where trusts have been created in the hope that means-testing would be avoided for the purpose of care fees in due course. Here the RNRB could be available if the property is still subject to the reservation of benefit at the time of death of the settlor and it passes to a lineal descendant. It will not be available if the trust is a discretionary trust.

IPDIs (immediate post-death interests)

One fairly common arrangement is where one spouse leaves a life interest to the surviving spouse and then to their children. In such a case the transfer will be exempt on the first death but when the value of the IPDI passes to the children on the second death the RNRB will be available. This can be tricky for couples who are not legally married. Say, one dies and leaves the property on a life interest to their partner (an IPDI)  with his (the first to die) children benefiting in remainder. As the couple are not married, the children of the first to die will not be lineal descendants of the second to die and so neither the RNRB nor the TRNRB will be available. It is the lineal descendant of the life tenant that must inherit for the RNRB to be available.

Comment

As can be seen from the above, there is quite a lot to remember about the RNRB when advising on making a will to ensure that the RNRB will be available. In some cases, it may be possible to reinstate the RNRB, even after the death and poor drafting, and we will consider this next month.

Next month we will also look at the various types of will trust that are still popular, and whether discretionary trusts are still useful in wills as well as using charitable legacies to mitigate tax. We will also look at the use of pilot trusts and how their popularity has changed following the introduction of the same-day additions rules.