Chartered Accountants and Professional Business Advisers

Where there’s a will there’s a way

The term ‘last will and testament’ is familiar to most of us, but the way an estate is distributed doesn’t always have to be exactly as the will sets out. For example, someone can make a claim for support under the inheritance laws of England & Wales (or their equivalent elsewhere), because they believe they should have been favoured in a will. Executors have to consider the validity of any such claim, sometimes assisted by the court.

A more common situation iswhere a beneficiary named in a will decides to disclaim a legacy or agree to a deed of variation (DOV). For example, someone named as a beneficiary in the will of one of their parents might prefer to skip a generation and divert the legacy to his or her own children. This can have useful tax effects, as it avoids the risk of inheritance tax on their own death.

Charitably-minded grandchildren might use a DOV to give added tax benefit by cutting the marginal tax rate on an estate from 40% to 36%. So bear in mind that the beneficiaries of your will can take action after your death, and if this is within two years, the tax implications can be the same as if the DOV was part of your original will.

Granting discretion

Alternatively, executors or trustees can be given discretion as to the manner and timing of the distribution of all or part of an estate, either on the death of the person making the will or perhaps that of a surviving spouse. Here too, there may be scope for tax-effective action within two years of the death (with trustees exercising their discretion). Whenever trustees are given discretion, a letter of wishes is a good idea.

Letter of wishes

Letters of wishes received some media attention recently in relation to the estate of the late Bruce Forsyth – an example of legitimate tax planning being sensationalised by the press. A letter of wishes is not binding, but gives trustees an indication of how they should act in the circumstances prevailing at the time. It is most relevant in the case of a will trust.

The letter of wishes may be changed as often as the settlor likes, without the formality required for a will or codicil. This means it can be updated to reflect changing financial or family circumstances, even if the will was made many years earlier This expression of wishes need not be in a formal letter as such; it could be in a video, audio clip or even be spoken (with notes taken at the time).

How it works

A bachelor leaves an estate of £2m. He had made lifetime chargeable transfers in the seven years before his death of £325,000. He leaves £80,000 in his will to charity and the rest to his favourite nephew.

Inheritance tax at 40% is payable on £1.92m, which is £768,000. This leaves £1.152m for the nephew.

If the nephew executes a DOV to give an additional £120,000 to charity, meaning that charitable bequests are up to 10% of the estate, the tax rate on the other 90% falls to 36%.

The amount available to the nephew after tax would be 64% of £1.8m, or £1.152m – exactly as before. But the charity would get an extra £120,000 at no cost to the nephew.