Estate planning - golden rules
Photo by Aaron Burden on Unsplash
Background to estate (not inheritance tax) planning
Clients often ask the same questions, so here is a Noddy’s guide to this area. It is not advice, and nothing beats going to a competent lawyer.
The simplest strategy is giving all your money away well (currently 7 years) before you die, but this runs the risk that you might run out yourselves. Estate planning involves organising that as much as possible of your estate goes as you wish but as only part of your overall objectives. This includes reducing the amount paid to undesirables including not only the Chancellor but also local Government (care fees), and your children’s ex-spouses on divorce.
Golden rule 1 – write a decent Will, which achieves what you want now and later
A valid Will is a good start. If married and you have a simple Will leaving everything to your spouse, that is a start, but only a start. The next step is to create a trust on your death, where the trustees (normally any surviving spouse plus a law firm) make the decisions. This could include allocating all to the surviving spouse or children (especially for smaller estates) and closing the trust, or allocating or lending part to them and keeping the trust going.
Golden rule 2 – ensure your assets fall under your Will, or are covered outside it
There is no point in expecting your Will to cover all your assets if most of your assets are owned as “joint tenants”, so on your death, the asset passes automatically to the survivor. This is most often the case on your house and is always the case on joint bank accounts. Severing the tenancy is cheap on property and free on bank accounts (you open two separate accounts). Of course, your spouse might not want to sever the property tenancy – they would then rely on your Will to receive your share of the house if they outlive you (and vice-versa).
Other than joint assets, the major things not normally covered under the Will are pensions and life policies written in trust. The trusts may be very old, and you need to check their provisions, and whether you can change them to what you now want.
Golden rule 3 – do not let the tax tail wag the investment dog
At age 90 and with plenty of spare money, estate planning should be more of an issue than at 60 and with just about enough. At neither age does it make sense to buy a rubbish investment just because it may become inheritance tax exempt.
Golden rule 4 – work out and then target what you want
This seems pretty obvious. If you want to live in the family house so your grandchildren can come to stay, or to give your children money now (when they need it) rather than on your death, let me know. We can’t always do both – but certainly not if you don’t know what you want.
Golden rule 5 – learn the facts, don’t follow the myths
There are some assumptions which are quite odd. The most significant relate to those who have no valid Wills, where people assume that their spouse (whether “common law” or actual) would always get everything, but here are some others:
“ISAs are tax-exempt, so I shouldn’t spend them”. Until you die, they are tax-favoured. When you die, unless they are invested in otherwise exempt investments (like qualifying AIM shares, which are exempt if in an ISA or not), they get added to your estate like everything else.
“All my pensions die when we both do”. Whilst usually true for company pensions in retirement, personal pensions are currently one of the best places to leave money on death. This wasn’t always the case, and might not be so in future, but if estate planning is the main or only objective, they should be towards the last to be touched.
“It isn’t sensible to take on debt for my children to repay”. If you borrow £100,000 to help the children when they need it, and on your death, there is say £400,000 less in your estate when they don’t need it, so what? If that £400,000 would have become £240,000 after inheritance tax, all the better.
“Trusts are expensive and complicated”. Trusts are in fact free and for simple circumstances and lower values, using your family only as trustees makes sense. Clearly, if you appoint professional advisers to manage the trusts and expect the trust to continue for 25 years, and there is only £50,000 in the trust, that is almost certainly a waste of money. By contrast, if there is £500,000 or £5M in the trust, not having a trust or having only family trustees is likely to cost a lot more than the fees avoided. The complication side of trusts is because that is what YOU have chosen.
There are also some semi-myths:
“I can do it later”. This might be fine, but how effective that strategy is depends on all sorts of factors which are unknown. There are however a lot of actions which have no downsides, so do these now.
“My lawyer says I can put my house in trust and avoid inheritance tax on it.” Whilst the Government has moved against this under Pre-Owned Asset Tax legislation, this continues to be available if done properly. It usually requires you to move out of the house - I have not so far seen a recent case which has worked without that. You should probably change the lawyer.
“I don’t care if there is inheritance tax – I won’t be around to pay it”. This is, in fact, the same as saying that you want the Government to be the main beneficiary of your Will. That may not be what you meant – if it is, fine.
A Will Trust in operation
Bob (63) and Sue (61) are married, retired and live in a £450,000 jointly owned house. Bob has ISAs worth £250,000 which he enjoys investing himself, and their main asset is Bob’s personal pension worth £1M from which they draw £50,000 p.a. before tax (£40,000 after tax), to live on. They have straightforward Wills leaving everything on the first death to the surviving spouse, and then the children, Jack and Jill, and Bob’s pension are also nominated in the same way.
Bob dies ten years later, at age 73. At that time the house is worth £650,000, Bob’s investments have done well and are also worth £650,000, being invested in a range of high-risk shares which qualify for IHT exemption, and the pension is still worth £1M.
Sue automatically inherits the house, the pension (with no tax) and, from the Will, the investments - with no tax on any of them. She sensibly decides to sell the investments she does not understand and invests the £1.65M with a balanced risk mandate. It grows a bit more than her drawings (£40,000 per year initially) but for the last 5 years of her life she needs care in her home costing an extra £40,000 p.a., so the pot falls to £1.5M after total drawings of £1M.
She dies at age 91 (20 years after Bob). At that time the house is worth £2M, and the savings pot is £1.5M. After 2 Nil Rate Bands of (by that time, say) £1M tax-exempt, the Chancellor receives 40% of £2.5M, so £1M and the children receive £1.25M each. Everyone is happy.
The Will Trust – a simple example
Instead of the above, Bob and Sue sever the tenancy on their house and write Wills including a Will Trust. On Bob’s death, the trustees (Sue and the lawyer) decide that everything Bob owned, which has gone into the Trust, should stay there being accessible to Sue. Because all his assets are IHT exempt (half the house being his Nil Rate Band), Sue now owns half a house with everything else owned by the Trust.
Over the next 20 years, the Trust invests exactly the same as Sue would have done, but because of a combination of trust tax and trustee charges, by Sue’s death, the savings pot has fallen to £1.3M (rather than £1.5M), plus the £1M loan to Sue.
Sue’s assets on her death are half the house so £1M. However she owes £1M to the trust so when the house is sold, and the trust loan is repaid, her net estate is nil. She doesn’t use her available Nil Rate Band (no planning is perfect), and no inheritance tax is paid with the children getting £1.65M each. Everyone is a bit happier (except the Chancellor) but we haven’t changed anyone’s lives: I suppose an extra £400,000 each is nice for the children to have.
Adding in some complexities
There are lots of factors which could make the flexibility of the Will Trust more useful.
When Sue needs care, the local authority will under current rules pay for some of it (Sue doesn’t own her home, and has no other money).
Sue might need a lot more than 5 years of care and (unlikely in this example, but entirely possible when the Wills were written) might run out of money if the local authority won’t help because she has money, having to move house (or into a home).
Sue would like to give money to her children (to help them when they need it) but either gives it to them outright, where on Jack’s divorce Mrs Jack gets a chunk, or loans it, where the loan stays in her estate for inheritance tax. The trust, by contrast, can loan to Jack (secured on his house) with no such risks.
Sue would like to give the children money as above, but having lost mental capacity is unable to do so. She has a splendid Power of Attorney in place, but her attorneys are not allowed to do this. The trust can do so.
Jill has no children and is wealthy (or terminally ill, or bankrupt). The terms of the trust allow the trustees to pay more to Jack’s family, or the trust could buy a house for her to live in, loan rather than gift to her or whatever.
By the time of Sue’s death, Jack is onto his second, third, or fourth marriage which is also heading for the rocks. The trustees can wait till the divorce has completed before giving him money (and might decide, given his track record, to give him an annual income, not the capital).
Sue decides that Jack and Jill don’t need money, and changes her Will to leave everything to her neighbour/ second husband/ charity. Under the trust, the lawyer will follow Bob’s original wishes which will make provision for this.
A change of Government sees inheritance tax rates increased to 75% on estates above £1M. Or maybe no change of Government is needed for this...
Will Trusts are attacked under a change of Government. The lawyer and Sue can decide whether it is worth retaining the Trust or just distribute to Sue as if the Will Trust had never been written.
Conclusion
The above is a very simple scenario, with a few complexities thrown in. I have deliberately selected a client who is not ultra-wealthy and wherein the simple example it is only money, but for all the family the worries about the complexities are real. The chances of no complexities occurring are lower than at least one of them.
The ideal Will is written properly now and remains good for 10-20 years (other than major family change, probably until you want to change executors), with a Letter of Wishes to the trustees which can be changed as you go along. It is essential that you use a competent law firm (not a one-man band, where your lawyer will retire before the second death, or an incompetent cheap one) for the advice.
EJA October 2018