Chapter 7(ii): Wills & Tax Planning

Question 1

What do we mean by tax planning?

Answer 1

You should be aware of the distinction between the following:

• Tax avoidance: the efficient and lawful arrangement of a client’s affairs in a manner which minimises their liability to tax.
• Aggressive tax avoidance: a form of tax avoidance which often involves the taxpayer entering into complex or artificial arrangements which have the overall effect of reducing their tax liability. These schemes comply with legislation but often do not reflect the intention behind the law. This kind of tax planning may involve exploiting loopholes or inadvertent gaps in drafting. Once HMRC become aware of a particular arrangement, ‘anti-avoidance’ legislation is often introduced to prevent further exploitation.
• Tax evasion: where a taxpayer withholds information about assets or income, or otherwise takes steps to avoid paying the tax they are liable for. This is unlawful.

This module is predominantly concerned with the first of these although it does briefly cover anti-avoidance rules. Tax evasion is outside the scope of the module.

Question 2

IHT Planning

Answer 2

The simple objective of IHT planning is to reduce the overall IHT liability on a person’s estate. The goals of the client are often threefold:

• to minimise IHT (usually by reducing the size of their taxable estate in advance of death by making gifts or acquiring exempt assets)
• to retain sufficient assets to maintain financial security during their own lifetime
• to provide adequately for their family after their death

These goals often conflict. It is important to ascertain the priorities of the client and consider whether it is practical or possible for them to undertake certain tax planning measures and still maintain their own or their family’s financial security.

Question 3

Tax Planning during a client’s lifetime

Answer 3

Tax planning may be achieved by a person making transfers of property during their lifetime or by dispositions in their will. This element considers tax planning during a client’s lifetime.

To comply with professional conduct obligations a solicitor must be competent to advise clients properly.

Advising on tax is generally considered to be one of the more technical areas of practice and when providing this advice clients must be advised fully on the implications of taking certain steps. It is crucial to remember that:

• actions taken to reduce IHT may result in a charge to capital gains tax (CGT) and / or result in a reduction in the client’s future income.
• once gifts have been made to individuals, or into a trust, it is not usually possible to get the assets or cash back, unless the beneficiary consents. Any steps taken to reverse previous actions may themselves have further tax consequences.
• anti-avoidance legislation may prevent the effectiveness of certain actions.

Question 4

Consider the relatively common scenario that follows:

X was not properly advised

Answer 4

Ten years before he died, X transferred a property to his niece (N). X thought this would save IHT when he died as his death estate would no longer include the property given away. After giving it away, X continued to live in the property rent free until his death

• The gift was a PET and not charged to IHT at that time. However, the transfer of ownership was a disposal for CGT purposes. X may have had to pay CGT.
• X survived more than 7 years after making the gift and it should therefore have been exempt from IHT. However, because X lived rent free in the property until he died, he made a gift with reservation of benefit (GROB) i.e. gave away an asset but continued to benefit from it. No IHT saving is achieved. The property is treated as never having left X’s estate and its value at the date he died is included in his death estate. The GROB rules are an example of the effect of anti-avoidance legislation.
• Under general law, gains accrued in assets owned by X at the date of his death (i.e. increases in value during his period of ownership) are disregarded when X dies. As X is not the legal owner of the property when he dies this CGT benefit is lost. The increase in value of the property in the 10 years since X gave it away would be chargeable to CGT in N’s hands.

Question 5

Exemptions and reliefs

Answer 5

It is worth recapping why lifetime exemptions and reliefs benefit a taxpayer.

If a transfer of value is made during a person’s lifetime this will be either a PET (which might fail) or an LCT. There are IHT consequences for both:

• A failed PET or LCT can give rise to an IHT charge in its own right. Provisions which exempt or reduce the chargeable value of the transfer result in a smaller tax bill.
• Even if the value of a PET/LCT is not high enough to trigger its own IHT charge, where the donor dies within 7 years following the transfer, the chargeable value of the transfer will ‘use up’ the NRB available for the death estate. As a result, a greater proportion of the death estate will be taxed at 40%. Steps which reduce the chargeable value of lifetime transfers leave a larger NRB and so help reduce the IHT liability on the death estate.

Question 6

Summary

Answer 6

ü Tax planning involves advising a client on the efficient and lawful arrangement of their affairs with a view to reducing their liability to IHT. This may involve a combination of advising about available exemptions and reliefs, writing certain death benefits into trust, and the careful use of PETs and LCTs.

ü The IHT consequences of dying in the 7 years following a chargeable transfer can be mitigated by the purchase of life insurance.

ü The timing of a transfer, so that it falls within one tax year or another, may form part of tax planning.

ü Steps that help reduce an IHT liability may have consequences for capital gains tax or income tax.

Question 7

IHT Planning by Will

Answer 7

The simple objective of inheritance tax (‘IHT’) planning by will is to minimise the tax liability on a person’s death to ensure the greatest provision for their surviving family. When drafting a will with this in mind, the following would usually be considered:

Exempt beneficiaries & qualifying assets

Allocation of exemptions

Nil rate band

Trusts

This element considers gifts to exempt beneficiaries and gifts of qualifying assets.

Question 8

Exempt Beneficiaries

Answer 8

You are aware that when a person dies there are two kinds of beneficiary who are exempt for IHT purposes:

Spouse / civil partner of the deceased

Charities

When drafting a will for a client they should be made aware of the exempt status of these beneficiaries as this may impact on the drafting of their will.

Note: All rules which apply to spouses and marriage apply equally to civil partners and civil partnerships.

Question 9

Gifts to spouse/civil partners

Answer 9

At the most basic level it is tax efficient for a client to leave assets to their spouse by will as all gifts to a spouse are exempt from IHT.

The relief applies to specific gifts and to the gift of residue

The amount of the relief is 100% of the value of the items inherited by the surviving spouse

It is clear that there is an advantage to leaving assets to a spouse and many clients may wish to leave assets to their spouse as a method of eliminating the charge to IHT.

However, spouse exemption only offers a tax saving if the client’s estate would otherwise be taxable.

Question 10

Advice for couples

Answer 10

If you take instructions from an unmarried couple, it may be appropriate to discuss the benefits of spouse exemption. “Getting married” may be the best tax planning advice they can be given!

Conversely, it is important for a client to understand that the benefit of spouse exemption on death is lost if the client is no longer married at that date.

Finally, if either one of the married couple are domiciled outside of the UK, the application of spouse exemption is more limited and your clients will need specific advice on this point.

Question 11

Gifts to Charity

Answer 11

It is tax efficient for a client to leave assets to a qualifying charity by will as these gifts are exempt from IHT, however, not all clients want to make charitable gifts.

This element considers the use of charity exemption where a client does want to make a gift to a charity in their will.

The relief applies to specific gifts and to the gift of residue

The amount of the relief is 100% of the value of the items inherited by the charity

Charity exemption only offers a tax saving if IHT would otherwise be payable following the distribution of a client’s assets on their death.

Question 12

Gifts to charity

Answer 12

There are various ways a client can benefit a charity by their will e.g. setting up a trust where a charity is included among the beneficiaries. This element focuses only on specific gifts.

Not all organisations that identify as a ‘charity’ will qualify for relief. When advising a client you must establish whether the organisation meets the qualifying criteria. Most charities registered by the Charity Commission will meet the criteria for IHT charity exemption.

Unregistered charities and those located abroad may qualify but their status requires particular consideration before this can be determined.

As a general point, when drafting a legacy to a charity you will need to ensure the gift is effective. If the legacy fails due to poor drafting, no IHT relief can be claimed.

Question 13

Gifts to Charity

Answer 13

A gift to a charity by will is fully exempt from IHT. In addition, the chargeable part of the estate may qualify for a reduced rate of IHT. In simple terms:

If a testator leaves 10% or more of their net estate to charity

the chargeable part of the estate is taxed at 36% (rather than 40%).

The value of the ‘net estate’ for these purposes includes the succession estate assets and additional items, including assets passing by survivorship.

A detailed consideration of the rules is beyond the scope of the module but you should be aware that if a client suggests making a charitable gift large enough to be relevant, you will need to advise on the application of the rules relating to the reduced rate of IHT.

Question 14

Specific Gifts

Answer 14

APR and BPR will be wasted if a specific gift of qualifying assets is made to an exempt beneficiary. For example:

“I give my shares in X ltd to my spouse”

By s 39A Inheritance Tax Act 1984 (‘IHTA’) the relief attaches to the assets and is not applied generally to the estate as a whole. As a result, both spouse exemption and BPR apply in relation to the same gift. BPR is wasted and an opportunity for the testator to have made more tax-free gifts to non-exempt beneficiaries is lost.

There is no guarantee the assets which qualified on the testator’s death will still qualify on the death of the survivor, so using the relief when the testator dies is often preferred.

From a tax planning perspective a client should therefore be advised against making specific gifts of qualifying assets to exempt beneficiaries.

However, despite the potential tax inefficiency, there are practical reasons why a testator may want their spouse to inherit these assets. For example:

Question 15

Specific gifts

Answer 15

there is no appropriate chargeable beneficiary to whom the assets can be given

the testator’s spouse requires the assets for their own benefit or to continue running a business.

A possible solution is for the testator to make a specific gift of the qualifying assets to a discretionary trust (a non-exempt beneficiary) and claim BPR or APR. The testator can then leave other assets to their spouse.

Provided the testator’s spouse is named as one of the trust beneficiaries they will be able to benefit from these assets despite not inheriting them directly. The value of the trust assets (whether they continue to qualify for relief or not) will remain outside the taxable estate of the survivor who, as a discretionary trust beneficiary, is not treated as the owner of trust assets.

Question 16

Gifts of residue

Answer 16

If qualifying assets are not specifically given away, and therefore fall into the residuary estate, APR/BPR do not attach to the assets (s 39A IHTA).

Instead, the benefit of the relief is apportioned generally between taxable and non-taxable beneficiaries.

Apportionment produces different results depending on whether an exempt beneficiary inherits by way of:

specific gift

a gift of residue

both of the above

Question 17

Gifts of residue

Answer 17

A detailed discussion of the apportionment rules is outside of the scope of the module but note that APR/BRP are wasted where apportionment allocates some/all of the relief to an exempt beneficiary.

This occurs where either:

All or part of the residuary estate (containing qualifying assets) passes to an exempt beneficiary, commonly the testator’s spouse.

The residue contains qualifying assets and there is a specific gift of non-qualifying assets (e.g. a cash legacy) to an exempt beneficiary (e.g. charity).

Question 18

Summary

Answer 18

All gifts to a spouse or charity are exempt from IHT and are a tax efficient method of giving away assets by will.

If a testator gives away 10% or more of their estate to charity, the chargeable part of the estate qualifies for a reduced rate of IHT at 36%.

Owning assets which qualify for APR or BPR provide an opportunity for a testator to make tax-free gifts to otherwise taxable beneficiaries.

By s 39A IHTA BPR/APR attaches to the qualifying assets where they are given away specifically, but, where the assets form part of residue, the reliefs are apportioned generally between exempt / non-exempt beneficiaries as a whole.

Question 19

Summary

Answer 19

APR/BPR are wasted to the extent the relief applies to a gift to an exempt beneficiary. This may occur where a specific gift of qualifying assets is made to an exempt beneficiary, or, as a result of apportioning the relief generally where the qualifying assets form part of the testator’s residuary estate.

The relief applies to specific gifts and to the gift of residue

The amount of the relief is 100% of the value of the items inherited by the surviving spouse

It is clear that there is an advantage to leaving assets to a spouse and many clients may wish to leave assets to their spouse as a method of eliminating the charge to IHT.

However, spouse exemption only offers a tax saving if the client’s estate would otherwise be taxable.

Question 20

Tax planning in wills: Allocation of exemptions

IHT Planning by Will

Answer 20

The simple objective of inheritance tax (‘IHT’) planning by will is to minimise the tax liability on a person’s death to ensure the greatest provision for their surviving family. When drafting a will with this in mind, the following would usually be considered:

Nil rate band

Exempt assets and beneficiaries

Trusts

Allocation of exemptions and reliefs

This element considers allocation of exemptions and reliefs.

Question 21

Taxable estates with exempt beneficiaries

Answer 21

This element focuses on the situation where IHT is payable in respect of the testator’s estate but some of the estate assets are passing to an exempt beneficiary.​

Statutory rules apply to ensure an exempt beneficiary is not taxed on their gift and the effect of these rules can vary depending on how the will has been drafted.​

Note that there is no particular issue for estates where:​

​-No IHT is payable (because the estate value is below the NRB / is below the NRB after all exemptions and reliefs have been applied)​

-​IHT is payable and all of the gifts in the will are made to chargeable beneficiaries (IHT is usually paid from residue unless testator states otherwise)​

​

Question 22

Exempt Beneficiaries

Answer 22

You are aware that when a person dies there are two kinds of beneficiary who are exempt for IHT purposes:

Spouse / civil partner of the deceased

Charities

The basic principle on which this element is based is that all gifts to exempt beneficiaries are made free of IHT.

This means the beneficiary should receive their inheritance without the cost of any IHT being directly applied to their gift i.e. the IHT exemption is allocated only to their gift.

Statutory rules determine the allocation of exemptions and may influence a testator’s instructions regarding their will. Note also that express wording within the will can affect the way in which the IHT is calculated.

Question 23

Not Direct Tax Planning

Answer 23

This element does not involve a direct form of tax planning. However, an awareness of this topic is required when advising a client who wants to take advantage of IHT exemptions under their will.

We are going to consider how the benefit of an IHT exemption is allocated in a scenario where a testator makes a will that contains the following:

Specific gift to exempt beneficiary and:

whole of residue to chargeable beneficiary, or

part of residue to chargeable beneficiary and part to exempt beneficiary

Specific gift to chargeable beneficiary (drafted as “subject to tax”) and:

whole of residue to exempt beneficiary

part of residue to chargeable beneficiary and part to exempt beneficiary

Specific gift to chargeable beneficiary (drafted as “free of tax”) and whole of residue to exempt beneficiary

Question 24

Specific gifts to exempt beneficiaries

Example

Answer 24

Example: Specific gift to exempt beneficiary with residue to chargeable beneficiary:

• £100,000 to spouse
• Residue to child

Only the residue is subject to IHT and the amount of IHT due is paid from residuary funds.

Spouse gets £100,000

Child gets the remaining sum after tax

Question 25

Example

Answer 25

Example: Specific gift to exempt beneficiary with residue to chargeable and exempt beneficiaries:

-£100,000 to spouse

-Residue equally between [charity] and children

Only part of the residue is subject to IHT (the charitable gift is disregarded). IHT is calculated on the children’s share and paid from this amount.

Spouse gets £100,000

Charity gets ½ residue

Children get other half of residue after IHT has been deducted

Question 26

Specific gifts (subject to tax)

Answer 26

Example: Specific gift to chargeable beneficiary (subject to tax) and residue to exempt beneficiary:

-£400,000 to child subject to tax

-Residue to spouse

The only part of the estate subject to IHT is the specific gift. The IHT due is paid from the legacy amount.

Child inherits £400,000 less the tax due

Spouse inherits the residue without any deduction for IHT

Question 27

Example

Answer 27

Example: Specific gift to chargeable beneficiary (subject to tax) and chargeable and exempt beneficiaries:

-£100,000 to daughter subject to tax

-Residue equally between spouse and son

Spouse’s share of residue is exempt.

IHT due is apportioned between the legacy and son’s half of residue.

Daughter gets legacy with IHT deducted (i.e. less than £100k)

Son gets share of residue with tax deducted (i.e. less than spouse)

Question 28

Specific Gifts (Free of Tax)

Answer 28

Example: Specific gift to chargeable beneficiary (free of tax) with residue to exempt beneficiary

-£350,000 to son free of tax

-Residue to spouse

Drafting legacy “tax free” means the son gets £350,000 (instead of a smaller sum after IHT is deducted).

The real value of the gift to the son is ‘£350,000 + IHT attributable to the legacy’. To calculate the true value of the gift and therefore the amount of IHT due “grossing-up” must occur. (This is outside the scope of the module).

£350,000 is paid to the son and the IHT is paid from other funds.

Question 29

Balance

Answer 29

The balance (i.e. residue) passes to spouse. The spouse receives less overall because IHT was due and residue was the only part of the estate from which it could be taken.

It is not possible for the will to result in a smaller tax liability by drafting all gifts as “tax free”. In this scenario, more IHT will be payable than if the testator had not made a tax-free gift to the son, as grossing–up would not have applied and the proportion of the estate subject to tax would have been smaller.

Question 30

Practice Alert: Double Grossing Up

Answer 30

Some wills may contain:

-specific gifts to chargeable beneficiaries and a gift of part of the residue to an exempt beneficiary, or

-specific gifts to chargeable beneficiaries where some but not all are “free of tax”.

In these scenarios double grossing-up is required.

These calculations are particularly complex and drafting a will where these would be required should be avoided where possible.

Question 31

Summary

Answer 31

All gifts to a spouse or charity are exempt from IHT and are a tax efficient method of giving away assets by will.

There are statutory rules that determine how the benefit of the exemption applies where an estate is divided between exempt and non-exempt beneficiaries and IHT is payable.

The overall effect of the rules is to ensure that exempt beneficiaries do not suffer the burden of the IHT payable in respect of the assets passing to the non-exempt beneficiaries.

Where IHT is payable as a result of specific gifts to non-taxable beneficiaries which are made “free of tax” and the residue passes to an exempt beneficiary, the amount of the specific legacy needs to be grossed-up before the IHT due can be calculated.

Question 32

Nil Rate Band

Answer 32

Maximising the amount of the NRB and the residence NRB (plus any transferred amounts) is an important consideration for all clients with taxable estates and will be relevant when taking instructions for a will. This element focuses on:

The extent to which a client ‘uses’ their NRB.
Drafting a gift of the NRB amount.
This element distinguishes between considerations for married and unmarried couples.

Question 33

1. The extent to which a client ‘uses’ their NRB.

Answer 33

‘Using’ the NRB on death refers to making transfers to non-exempt beneficiaries (which are taxed at 0% on the value which falls within the NRB).

The NRB is not used at all if a client leaves the whole of their estate to an exempt beneficiary. The exemption reduces the taxable value of the estate to zero.

The NRB will be used in part if either i) the total value of the estate is less than the NRB, or ii) the total value of gifts to non-exempt beneficiaries is less than the NRB amount.

The NRB is used in full if the total value of gifts to non-exempt beneficiaries is greater than the NRB.

Question 34

IHT is only payable on an estate where the NRB is used in full.

Answer 34

If a client does not wish to make any gifts to an exempt beneficiary the NRB will be applied against their taxable estate in the usual way. The client has no choice about whether to use it or not.

A married testator who wants to leave assets to their surviving spouse may choose the extent to which their NRB is used.

The testator could:

leave their whole estate to their spouse, so spouse exemption applies and none of the NRB used, or,

make gifts to non-exempt beneficiaries and give the remainder to their spouse, so the NRB will be used in whole or part (depending on the value of the gifts to non-exempt beneficiaries).

If a couple (married or not) have children, it is common for the couple to want to leave assets to each other following the death of one of them, and on the death of the survivor, leave the estate to their children.

Question 35

IHT is only payable on an estate where the NRB is used in full.

Answer 35

A client will often be interested in reducing the IHT burden for their family as a whole rather than just themselves as an individual.

Tax planning often requires the will drafter to consider the IHT implications following the death of the couple and their combined estate. The client objective is often long term and is to maximise the amount that can pass down a generation to children or grandchildren.

Question 36

NRB: Married couples

Answer 36

Prior to 2007 it was not possible for one spouse to pass on their NRB to the survivor.

To the extent a testator’s NRB was not used on their death it was wasted.

A will that left everything to a spouse did not utilise any of the NRB because the whole estate qualified for 100% spouse exemption.

The assets of the first to die would pass to the survivor and be taxed on the survivor’s death after the deduction of only the survivor’s NRB.

Question 37

Example: Prior to NRB transfer

Answer 37

A and B are married. Both have estates worth £500,000.

Will of A (first to die)

• Everything to spouse (B)

A’s estate is not taxed as it qualifies for spouse exemption.

None of A’s NRB is used.

When B dies their estate includes their own assets plus those inherited from A (the estates are ‘bunched’ together).

Will of B (survivor)

• Everything to children

B’s estate (worth £1m) is taxable as it is passing to non-exempt beneficiaries. Only B’s NRB can be claimed.

A’s unused NRB is wasted.

Question 38

Solution

Answer 38

To avoid A’s NRB being wasted A could make use of it by giving a sum equal to the NRB:

• to a non-exempt beneficiary (e.g. their children)
• to a trust (a discretionary trust was commonly used and B would be one of the beneficiaries to ensure B could benefit from the portion of the estate not passing to them directly)

B would receive the balance above the NRB.

This was tax efficient because:

• IHT would not be payable following A’s death (the gift of the NRB would be taxed at 0% and the balance passing to B would be spouse exempt).

Question 39

Solution

Answer 39

• Although IHT would be payable following B’s death, B’s estate would be smaller than if they had inherited everything from A and thus less tax would be paid.
• Ultimately, the children would receive a larger inheritance as both NRBs were used and B’s tax liability would be smaller.

Following the introduction of the transferrable NRB between married couples in 2007 it is no longer a primary concern to ensure that the first of a couple to die uses their NRB at that time.

This is because the survivor is entitled to their own NRB plus the unused proportion of their spouse’s NRB.

It does not matter when the first spouse dies, provided the survivor dies after the introduction of the transferrable NRB, it will be available.

Question 40

Example: After NRB transfer

Answer 40

A and B both have an estate worth £325,000.

A’s Will (first to die)

• Everything to B (spouse)

A’s estate is not taxed as it qualifies for spouse exemption.

A does not use any of their NRB.

B dies later and their estate includes their own assets plus those inherited from A.

Question 41

Example: After NRB transfer

Answer 41

B’s Will (survivor)

• Everything to children

B’s estate, worth £650,000, is taxable as it is passing to non-exempt beneficiaries.

B’s estate is entitled to both A and B’s NRB. The whole of B’s estate is within the combined amount (£325,000 + £325,000).

No IHT is due. No NRB is wasted.

Question 42

NRB: Married couples

Answer 42

It is therefore no longer crucial to ensure the first of a married couple to die makes use of their NRB, because to the extent it is unused it can be claimed by the survivor. However, a client may want to use their NRB /not leave everything to the survivor. For example, if:

• the client intends to benefit someone other than a spouse.
• the client does not want their surviving spouse to control all the family assets (perhaps where the client has children from a previous marriage).

Question 43

NRB: Married couples

Answer 43

• there is an advantage to keeping the survivor’s estate smaller. E.g. to reduce the value of assets within the remit of local authority assessment for care home costs, or, if the value of their combined estates will be more than £2M thus limiting the application of the residence NRB on the survivor’s death.
• the value of some assets will likely increase more rapidly than any increase in the NRB over time.
• the survivor will not have enough assets to make full use of a transferred nil rate band.

Sometimes a client may decide to use (or not use) their NRB based on an expectation of how the NRB may change in the future.

Question 44

Will 1 & Will 2

Answer 44

Will 1

• £NRB to children
• Everything else to spouse

Will 2

• Everything to spouse

However, a possible advantage to Will 2 is that the amount of the NRB is not fixed until the death of the survivor.

If the NRB increases in value between the first and second death, and the value of the combined estates is sufficient to make use of any increase, it may be better for the first spouse not to use their NRB. See the example which follows:

Question 45

Example: Fixing of the NRB

Answer 45

T’s Will 1

• £NRB to children
• Everything else to spouse (S)

T’s Will 2

• Everything to spouse (S)

Assume the NRB at T’s death is £325,000 but has increased to £400,000 by the time S dies.

Will 1: T’s estate is entitled to a NRB of £325,000 (applied against the gift to the children). S’s estate is entitled to a NRB of £400,000. Total NRB for their combined estates is £725,000.

Will 2: T does not use their NRB. S’s estate is entitled to a full NRB for both S and T (i.e. 100% of T’s NRB is transferred to S). The amount of the NRB is fixed at S’s death. The total NRB for their combined estates is £800,000.

Question 46

NRB: Unmarried Couples

Answer 46

Spouse exemption is not available for unmarried couples so the IHT considerations will be different.

If both parties have estates large enough to attract IHT, tax will be payable on the first and second deaths (unless other exemptions apply). These clients may be concerned with ‘bunching’.

Will of A (first to die)

• Everything to B

Will of B (survivor)

• Everything to children

A dies:

IHT is payable on the value of A’s estate above the NRB. B inherits assets from A after they have been taxed.

Question 47

B dies

Answer 47

B’s estate now includes their own assets plus those inherited from A (the estates have been bunched together). IHT is payable on the value of B’s estate which is above the NRB.

The value of the assets inherited from A may be re-taxed as part of B’s estate before passing to their children.

A couple who want to limit the amount the survivor inherits (to avoid B’s estate becoming too large) could make gifts to children (or other family members) on the first death rather than leaving everything to each other.

However, if children are young and /or the couple want the survivor to be able to benefit from all of the estate of the first to die, alternatives can be considered.

Question 48

Alternative considerations

Answer 48

One option is for the first of a couple to die to leave an amount into a discretionary trust instead of to the survivor directly.

If the survivor and their children/grandchildren are named as beneficiaries of the trust they can benefit from the assets (although will not have complete control over them). When the survivor dies their taxable estate does not include the assets held in the trust.

Although there are administrative costs to running a trust, and beneficiaries do not have unrestricted or certain access to the trust fund, these considerations are often accepted when the possible tax saving is considered. See the basic example that follows:

Question 49

Examples: Unmarried couples

Answer 49

Scenario 1

• A dies leaving an estate worth £500,000 to B.
• IHT payable: £70,000 (£500,000 – NRB of £325,000. Balance of £175,000 @ 40%)
• Assume B dies leaving an estate worth £830,000 (residue of £430,000 from A plus £400,000 of B’s own assets) to their children.
• IHT payable: £202,000(£830,000 – NRB of £325,000. Balance of £505,000@ 40%)

Total IHT paid: £272,000.

Question 50

Examples: Unmarried couples

Answer 50

Scenario 2

• A dies leaving an estate worth £500,000 to a discretionary trust. B and the children are the trust beneficiaries.
• The discretionary trust is not exempt so all of A’s estate is taxable. IHT of £70,000 is payable as per Scenario 1.
• B dies leaving an estate worth £400,000 to their children.
• IHT payable on B’s death is: £30,000 (£400,000 - NRB of £325,000. Balance of £75,000 @ 40%).

Total IHT paid: £100,000.

Question 51

NRB: Unmarried couples​

Answer 51

A different factor to consider is where one party has an estate worth less than the NRB. ​

If the poorer of the couple dies first, their NRB cannot be used in full, and to the extent it is unused it is wasted. This is not an issue if the richer of the couple dies first leaving their estate to the survivor of the couple, however, the order of death will not be known in advance. ​

Here, tax planning may involve the richer of the two making transfers during their lifetime to equalise the value of the two estates and then each person making wills that benefit the other.​

Provided both estates are worth more than the NRB the NRB will be used in full irrespective of who dies first.​

Question 52

Residence NRB

Answer 52

If your client owns residential property further consideration will be required if the client wishes to make use of the separate residence NRB (‘RNRB’) and the transferred RNRB.

You will recall that the criteria for claiming the RNRB are:

• qualifying residential interest
• is left absolutely
• to a lineal descendant (children, grandchildren etc)

The NRB is reduced (tapered) for estates worth more than £2M.

The law relating to the RNRB is not covered in detail in this element. However, if a client has an interest in residential property and wishes to benefit lineal descendants they should be advised on how to structure their will to ensure the RNRB can be claimed.

Question 53

Residence NRB

Answer 53

Factors to consider:

Is a specific gift of property being made to beneficiaries, or is the property part of the general residue of the estate?
* Where the residence is part of the residue, and this is shared between lineal descendants and non-lineal descendants, it makes things more complicated.

Question 54

Residence NRB

Answer 54

Is the property passing directly to the lineal decedents or not?
* Where an age contingency is attached to the gift in the will, and the beneficiary is under this age when the testator dies, the RNRB may not apply.

• If property is left into certain types of trust, rather than by way of direct gift, the RNRB may not apply.

The tax saving obtained by making use of the RNRB should be considered alongside other client objectives.

Question 55

2. Drafting gifts of the NRB

Answer 55

If a client decides to give away ‘the NRB’ to a non-exempt beneficiary it is important to identify exactly what is intended. For example, the gift of a fixed sum (as below) is not advised because:

a) If the testator does not have a full NRB available when they die, part or all of the gift may end up being taxable when this was not intended.

b) The amount of the NRB may change over time. If the NRB increases between the date of the will and the date of the testator’s death this may result in a missed opportunity to make full use of the tax-free amount.

Question 56

2. Drafting gifts of the NRB

Answer 56

“I give the sum of £325,000 to my daughter”

A formula clause is usually preferred:

“I give as much of my nil rate band as is available to my daughter”

However, note that where a formula clause is used, there should be certainty about what is meant by any reference to the NRB. These clauses may or may not include the amount of the:

• NRB transferred from a pre-deceased spouse
• RNRB and any transferred RNRB

A gift of the client’s ‘NRB’ may be of a smaller amount than a gift of “the maximum amount that can be given without tax being payable”.

A testator who wants to maximise the use of their NRB (often before paying the residue to their spouse) will prefer a clause which covers all of the possible NRB amounts, compared with a testator who wishes to cap the maximum amount that would be given to the beneficiary.

Question 57

Summary

Answer 57

• A married testator should consider whether or not to make use of their NRB in the event they pre-decease their spouse.

-The first of a married couple to die may leave everything to the survivor and avoid using their NRB, which can be transferred to the survivor and claimed on their death instead. The amount of the transferred NRB is determined on the second death.

ü–There are practical reason why a married client may not want to leave their whole estate to their surviving spouse.

Question 58

Summary

Answer 58

-An unmarried couple may want to ensure that both NRBs are used in full, and prevent assets inherited from the first of them to die being taxed again as part of the estate of the second to die.

• If a client wishes to make use of the residence nil rate band, the will must be carefully drafted to ensure that the qualifying criteria can be met.
• When drafting a gift of the nil rate band, a formula clause should be used instead of specifying a fixed sum. The wording of a clause should make the value of the gift clear; will it include or exclude any transferred or residence NRB?

Question 59

Overview

Answer 59

A testator may make a gift into trust by their will.

A trust does not have separate legal personality. Therefore, a gift into trust takes effect as a transfer to the trustees. The trustees will be the legal owners of the assets (collectively referred to as the trust fund). The equitable and beneficial interests lie with the beneficiaries.

The testator may leave a specific gift of cash or assets or give the whole or part of the residue of their estate to a trust.

It is possible for a testator to add assets to a pre-existing trust. In this case the drafting is fairly simple, and the will simply needs to identify the trust to which the assets are being given. However, it is more common for a new trust to come into existence by operation of the terms of a testator’s will.

Question 60

Overview

Answer 60

A will that contains the following type of clause creates a new trust. The clauses in the will which follow should contain the detailed provisions.

“I give the sum of £325,000 to my Trustees to hold on trust in accordance with the following terms…”

It is more common than not for a testator to appoint the same people to act as both executor of their estate and as trustee of any trust created by their will.

A will that contains the following type of clause is adding to an existing trust. The will does not need to contain further detailed clauses.

“I give my Residuary Estate to the trustees of the ABC Family Settlement to hold in accordance with its terms”.

For the purpose of this element you should assume that a will has been professionally drafted and any gift into trust satisfies the legal requirements to be valid.

Question 61

Overview

Answer 61

A trust created on death by a testator’s will is referred to as a ‘will trust’. Where the testator creates a trust by will the:

will is the trust deed

testator is the settlor

trust comes into existence on the date of the testator’s death when the provisions of the will become operative (not on the date the will was executed).

Drafting a will that creates a trust can be complicated. Express wording in the will is required to:

Set out the terms of the trust

Appoint trustees

Identify beneficiaries

Identify which part of the estate the trust will apply to

Set out the scope of the trustees’ powers

Question 62

For tax planning purposes there are four main types of will trust you are likely to see:

Answer 62

Discretionary Trust: A trust for the benefit of a group of beneficiaries, none of whom have any fixed right to trust assets. The trustees have absolute discretion over capital and income i.e. when, how much and to whom any distributions should be made

Life Interest Trust: A trust for the benefit of a life tenant (entitled to income during their lifetime) and the remainderman (entitled to capital when the life interest ends, usually on the death of the life tenant). The trustees do not have complete discretion over distributions from the trust fund.

Trusts for young people: Trusts that benefit of the testator’s children.

Trusts for disabled people: Trusts that provide for those with physical or mental disabilities.

This element only considers the trusts shown in bold. The law relating to trusts for young and vulnerable people is beyond the scope of this module.

Question 63

Discretionary will trusts

Answer 63

If a settlor creates a discretionary will trust there is no immediate tax saving for the testator (or their estate) compared to making an outright gift. No spouse exemption can apply (even if the spouse is one of the trust beneficiaries) and the IHT position for both of the examples below is (in principle) the same:

WILL

I give all my estate to the ABC Discretionary Trust

ABC Discretionary Trust

Testator’s children are the trust beneficiaries

WILL

I give all my estate to my children

Question 64

Drafting discretionary will trusts

Answer 64

Where a gift is made to a discretionary trust it will be drafted as either of the following:

Discretionary trust of residue: the whole or part of the residuary estate passes to a discretionary trust and the exact amount cannot be determined until the administration is complete.

Legacy to a discretionary trust: a fixed sum or a sum ‘equal to the nil rate band’ passes to a discretionary trust. The amount is fixed / calculated.

It is important to know that the residence nil rate band (RNRB) does not apply if the deceased’s residential interest passes to a discretionary trust, even if the testator’s children are among the beneficiaries. This is because the children are not inheriting ‘directly’. Careful consideration is required if a client wishes to make use of the RNRB and leave assets to a discretionary trust e.g. making a gift into trust of assets .

Question 65

Non-tax reasons for discretionary will trust

Answer 65

It is useful to be aware of the succession / non-tax reasons a settlor may wish to set up a discretionary trust instead of leaving gifts directly to individuals.

Flexibility: The testator is not required to know in advance exactly how their estate should be distributed after their death and the changing needs of beneficiaries can be accommodated by the trustees having regard to the circumstances at the relevant time.

A ‘letter of wishes’ is commonly drafted by a testator and given to the trustees describing how the testator would like the trustees to exercise their discretion. These letters are not legally binding on the trustees but are a useful reference point.

Protection: The assets in a discretionary trust are not controlled or owned by any single beneficiary and are therefore usually protected from claims by i) a beneficiary’s creditors should they be declared bankrupt, or ii) a beneficiary’s spouse as part of divorce proceedings.

Question 65

Practice Point - Trust taxation

Answer 65

We have seen that there is no inheritance tax charge in relation to the discretionary trust assets for the estate of any individual beneficiary.

However, you should be aware that instead of taxing an individual beneficiary HMRC apply IHT charges to the trust. These charges (paid by the trustees from the trust fund) are usually significantly smaller than the IHT that would be payable if a beneficiary owned the trust fund outright on their death.

The tax charges applied to discretionary trusts are commonly referred to as the ‘relevant property regime’.

Trust taxation and the relevant property regime are outside the scope of this module.

Question 66

2 Year discretionary will trusts

Answer 66

These discretionary will trusts are drafted with the intention they only last for the period of two years following a testator’s death. The limit of two years is with reference to s 144 Inheritance Tax Act 1984 (‘IHTA’) by virtue of which distributions of capital from a discretionary trust made by the trustees within two years of the testator’s death are deemed to have taken place under the deceased’s will for IHT purposes and not by the trustees. (NB there is no equivalent provision for CGT purposes).

Question 67

2 Year discretionary will trusts

Answer 67

A two-year discretionary will trust allows the testator a great deal of flexibility; they do not have to decide how their estate should be distributed when their will is drafted, instead the trustees decide who (among the trust beneficiaries) should inherit and what they should receive after the deceased has died.

It should be obvious that these trusts would only be used where the testator trusts that the trustees will make appropriate decisions. Often a testator will appoint their surviving spouse as one of the trustees.

Question 68

Consider the following scenario:

Answer 68

A testator leaves their entire estate worth £400,000 to a discretionary trust.

The testator’s spouse, children and a charity are among the beneficiaries.

No exemptions apply. The NRB is worth £325,000. No RNRB can be claimed as the children do not inherit an interest in the property.

When the testator dies IHT will be payable as the value of the estate is greater than the NRB.

One year after the testator’s death the trustees pay ½ of the trust fund to the testator’s spouse, ¼ to charity and ¼ to the testator’s children. These payments are treated under s.144 IHTA for IHT purposes as having been made by the testator‘s will not the trustees:

Question 69

Consider the following scenario:

Answer 69

Therefore spouse and charity exemption can be claimed

after they have been applied the value of the estate is less than the NRB (which could also now include the RNRB if a residential property had been distributed to the children)

a refund of all of the IHT paid following death can be claimed.

The trust has not retained any assets and comes to an end.

Question 70

Life interest will trusts

Answer 70

If a testator creates a life interest trust by will, spouse exemption can be claimed on the amount passing to the trust provided the testator’s spouse is the life tenant. There is no spouse relief if the testator’s spouse is a remainder beneficiary.

This means:

there is tax advantage to the testator (or their estate) compared to the testator making a gift to a non-exempt beneficiary.

the IHT position would be the same whether a testator left their entire estate to their spouse absolutely, or left their entire estate on a life interest trust and named their spouse as the life tenant.

Testator A leaves their entire estate on the terms of a life interest trust, naming their spouse as the life tenant and their children as the remainder beneficiaries.

Question 71

Life interest will trusts

Answer 71

No IHT is payable because spouse exemption will apply to the assets passing into the trust.

Testator B leaves their entire estate on the terms of a life interest trust, naming their sister as the life tenant and their spouse as the remainder beneficiary.

IHT will be payable unless the value of the estate is below the nil rate band. No spouse exemption applies.

Testator C leaves their entire estate to their spouse absolutely.

No IHT is payable because spouse exemption will apply to the assets passing directly to their spouse.

The estates of Testator A and Testator C are taxed in the same way. A testator who is married or in a civil partnership has the opportunity to benefit from the practical advantages of a trust while maintaining the benefit of the IHT exemptions.

We will consider the practical reasons why Testator A may have wanted to create a life interest trust.

Question 72

Life interest will trusts: Practical advantages

Answer 72

The key practical advantage of a life interest trust compared to an outright gift is that the testator can control the ultimate destination of their estate. The testator can specify who benefits as the life tenant whilst preserving the capital of their estate for other beneficiaries.

This structure is particularly useful if the settlor has remarried and has children from a previous marriage, or thinks their spouse may marry again in the future. The concern is that a surviving spouse may ultimately leave assets they inherited under the testator’s will to someone the testator did not know e.g. their second spouse or children from another marriage.

A testator who sets up a life interest will trust, naming their spouse as life tenant and their own children as remaindermen, will obtain the same tax advantage of spouse exemption as if their estate passed directly to their spouse, but will also the ability to preserve their assets for other family members after their spouse dies.

Question 73

Practical considerations

Answer 73

The following practical matters should also be considered:

A life tenant is only entitled to trust income (not capital) and the amount of income generated may not be sufficient. The testator should consider the needs of the life tenant, the amount of income likely to be generated by the trust and other resources of the life tenant. The ideal is to achieve the following:

Question 74

Practical considerations

Answer 74

Life tenant’s needs = life tenant’s resources + trust income

If the life tenant’s needs are likely to exceed their resources plus trust income other options should be considered, for example:

Make the trust fund larger (if possible) so more income is generated, and/or

Ensure trustees have express powers to advance capital and/or to make loans to the life tenant if this is needed.

Question 75

Summary

Answer 75

A testator may create or add to an existing trust by operation of express clauses in their will.

A discretionary trust offers the advantage of flexibility regarding the future needs of the beneficiaries and a longer-term tax advantage to the beneficiaries compared with a direct inheritance. However, no spouse exemption can apply on a gift to the trust and the RNRB cannot be claimed if the residential interest passes to a discretionary trust.

Question 76

Summary

Answer 76

S144 IHTA will apply to distributions made from a discretionary will trust in the 2 years following a testator’s death and these distributions are treated for IHT purposes as having been made under the testator’s will, not by the trustees.

A life interest trust creates fixed interests in the trust fund (the life tenant and remainder beneficiaries have defined rights) and spouse exemption can be claimed if the spouse is the life tenant. The testator can retain control over the destination of their estate. However, if a life tenant is likely to require access to the trust capital express powers permitting trustees to pay or loan capital to the life tenant must be expressly drafted.

Question 77

Wills: Professional conduct

SRA Code of Conduct for Solicitors (‘CCS’)

Answer 77

The CCS form part of the SRA Standards & Regulations and sets out the professional standards the SRA expect of solicitors authorised to provide legal services.

The standards are a framework which applies to all those working within a law firm. Each individual must exercise personal judgment regarding how to meet the standards, taking into account their particular situation, the nature of their client, and their area of practice.

Question 78

SRA Code of Conduct for Solicitors (‘CCS’)

Answer 78

While the CCS is drafted in general terms the SRA have produced guidance notes to assist with the interpretation and implementation of the standards and there are certain parts of the CCS which are particularly relevant when drafting wills:

Question 79

Third Party Instructions

Answer 79

CCS 3.1: You only act for clients on instructions from the client, or from someone properly authorised to provide instructions on their behalf. If you have reason to suspect that the instructions do not represent your client’s wishes, you do not act unless you have satisfied yourself that they do.

A solicitor must take instructions for a will from their client only, and should not take instructions from anyone else (unless a third party is authorised by the client to provide instructions). A solicitor should be aware of the risk of (and avoid) someone giving instructions on behalf of another when meeting a couple or members of the same family together.

A solicitor should be alert to the risk of undue influence. A will made under undue influence or as a result of fraud will not be valid.

Question 80

Providing a competent service

Answer 80

CCS 3.2: You ensure that the service you provide to clients is competent and delivered in a timely manner.

CCS 3.3: You maintain your competence to carry out your role and keep your professional knowledge and skills up to date.

When preparing a will for a client you must be competent to advise on all aspects of the retainer, including any tax and trust implications. A will must be drafted promptly and a time delay gives rise to the risk that the testator dies intestate or with an earlier valid will that does not reflect their current wishes. These aspects of the CCS are pervasive and apply to all clients.

In addition to the CCS (breach of which may give rise to SRA sanctions) there are overlapping common law obligations which require a solicitor to exercise a duty of care and skill (breach of which may give rise to a claim for negligence against a solicitor personally). These duties are considered later in the element.

Question 81

Client’s circumstances

Answer 81

CCS 3.4: You consider and take account of your client’s attributes, needs and circumstances.

It is with reference to this rule that a legal practitioner should be alert to any indication that their client may lack testamentary capacity. A common legal challenge for anyone seeking to disregard the effect of a will is to claim that the testator lacked capacity when it was made, which if true, renders the will invalid.

A solicitor has a duty to ensure their client does have capacity and also to retain evidence to support this should the will be challenged at a later date.

When taking instructions for a will a solicitor must satisfy themselves the client has testamentary capacity.

If testamentary capacity is in doubt the testator’s consent should be obtained to approach their medical practitioner for confirmation of capacity and to make a record of the findings (known as the ‘golden rule’). The purpose of the assessment and the test for testamentary capacity should be explained to the medical practitioner so they are able to make a decision.

Question 82

Client’s circumstances

Answer 82

If testamentary capacity is confirmed: a will can be made but it is advisable to ask the doctor to act as a witness and to record their findings.

If testamentary capacity cannot be confirmed: a will should not be prepared. The only will which can be made is a statutory will following an application to the Court of Protection under s 16 Mental Capacity Act 2005.

Whether or not there are concerns, a detailed file note of the client’s instructions and an express statement regarding the solicitor’s assessment of the client’s testamentary capacity should be kept. An attendance note confirming there were no concerns may be useful evidence later on should the will be challenged.

In Hawes v Burgess 2013 it was held that where an experienced solicitor had made a contemporaneous attendance note recording his view that a testator had capacity it would require strong evidence for the court to find otherwise.

Question 83

Gifts to solicitors in a will

Answer 83

CCS 6.1: You do not act if there is an own interest conflict or a significant risk of such a conflict.

A client may wish to leave property to you or a member of your firm in their will. There is no mandatory rule which prohibits this, but there is a risk of a conflict of interest and it is recommended that you should refuse to act for a client where the client is proposing to make a gift of a significant value to you or a member of your family, or a member of your firm or their family, unless the client takes independent legal advice.

A gift may be significant in itself, or when considering the size of the testator’s estate.

NB: There is no presumption of a testator’s knowledge and approval where the person who prepared the will is a beneficiary. Those attempting to prove the will would have to prove that the testator did know and approve of the contents.

Question 84

Common Law duties

You should be aware of:

Answer 84

A general common law duty to prepare a will for a client with due skill and care, and within a reasonable time (White v Jones).

the obligation to draft a will which gives effect to the testator’s instructions. Mistakes often only come to light after the testator’s death, when it is often too late to rectify the errors. If the testator fails to execute a valid will which achieves their intended aims because of the legal practitioner’s breach, the practitioner may be liable to the testator’s intended beneficiary.

Question 85

Common Law duties

You should be aware of:

Answer 85

The requirement to advise a client on how to execute their will. In Ross v Caunters the defendants were liable for not advising on the effect of s 15 WA in relation to a witness who was a spouse of a beneficiary. In Esterhuizen v Allied Dunbar Assurance it was considered that a solicitor would likely be negligent by simply leaving a will with the testator to be executed and witnessed and to do no more.

Question 86

Good practice: Taking instructions

Answer 86

To obtain full and clear instructions to draft a will a personal interview with the client will usually be necessary. A solicitor should obtain written confirmation from the client that they want the law firm to act and the terms of the instructions.

Many firms use checklists or questionnaires to ensure key information is obtained from the client. However, a solicitor should beware of simply completing a checklist and not fully interviewing the client or listening to their instructions when ascertaining the client’s personal circumstances and goals.

Once relevant information has been recorded, the client should be advised of the alternative ways of disposing of their estate. It may also be relevant to give advice about lifetime gifts including tax planning matters.

Question 87

Taking instructions: IPFDA 1975

Answer 87

One very important issue to consider when taking instructions is the risk that a claim may be made against the client’s estate under IPFDA 1975. The following steps should be taken to minimise the risks and ensure that full advice is given:

Ensure that you take full details of all members of the family and any dependants to enable you to provide full advice.

If there is a former spouse or civil partner, check the ancillary relief order to see whether IPFDA 1975 claims have been barred under s15 (which is normal where there is a clean break order).

If the deceased is maintaining someone other than immediate family members then consideration should be given as to whether that maintenance could be terminated. If so, ensure there is a written record to evidence the termination.

If there is the possibility of a claim from someone with special needs then the client needs to be aware that social services could pursue a claim on behalf of that person.

Answer 88

If there is a potential applicant that the client does not wish to include in the will despite your advice, then get the client to provide a written statement explaining why no provision has been made. The statement should be kept with the original will and copies kept on the client file and with the executors (if the client agrees).

Irrespective of the practical steps taken by a testator, clients should be advised that it is not possible to prevent a future claim being made against their estate under the IPFDA 1975 Act or guarantee that any such claim will fail.

In Ilott v The Blue Cross and others [2017] UKSC 17 the testator left the whole of her estate to charity and nothing to her only child (from whom she was estranged).

The testator in this case had left a note with her will explaining why she was dis-inheriting her adult daughter and making it clear she did not wish her to receive anything.

Despite this, a claim made by the testator’s daughter following her mother’s death was successful

Question 89

Good practice: review of wills

Answer 89

Once a testator has made their will it is important to ensure it is reviewed at regular intervals either generally (to take account of tax changes/changes in testator’s general financial situation) or specifically if certain events occur. These could include such events as:

marriage or civil partnership;

divorce or dissolution of civil partnership;

birth of children;

death of close relatives/beneficiaries;

substantial change in the value of assets;

recent inheritance of their own; and

moving or acquiring assets abroad.

Question 90

Summary

Answer 90

Professional conduct matters pervade all aspects of your work irrespective of the department you work in. However, when providing will drafting services, particular attention should be given to:

CCS 3.1 - 3.4

CCS 6.1

IPFDA 1975

Common law duties and obligations

Your firm’s best practice