SQE - WILLS AND THE ADMINISTRATION OF ESTATES (FLK2) - DECK 3

What is the simple objective of Inheritance Tax (IHT) planning?

The simple objective of IHT planning is to reduce the overall IHT liability on a person's estate.

What are the threefold goals often pursued by clients in IHT planning?

The threefold goals often pursued by clients in IHT planning are:

1. Minimizing IHT by reducing the size of their taxable estate through gifts or acquiring exempt assets.

2. Retaining sufficient assets to maintain financial security during their lifetime.

3. Providing adequately for their family after their death.

What potential conflicts arise in pursuing the three goals of IHT planning, and why is it crucial to ascertain the priorities of the client?

The three goals of IHT planning may conflict, and it is crucial to ascertain the priorities of the client because actions taken to reduce IHT may result in a charge to capital gains tax (CGT) and/or a reduction in the client's future income. It's important to consider whether certain tax planning measures are practical or possible while maintaining the client's or their family's financial security.

What must a solicitor be competent to do when advising clients on tax planning, and why is advising on tax considered a technical area of practice?

A solicitor must be competent to advise clients properly on tax planning. Advising on tax is considered a technical area of practice, and clients must be fully informed of the implications of taking certain steps.

What are some crucial considerations when advising clients on IHT planning?

Some crucial considerations when advising clients on IHT planning include:

• Actions taken to reduce IHT may result in a charge to CGT and/or a reduction in the client's future income.

• Once gifts are made, it is not usually possible to get the assets or cash back without the beneficiary's consent.

• Anti-avoidance legislation may prevent the effectiveness of certain actions.

Why do lifetime exemptions and reliefs benefit a taxpayer, and what are the potential IHT consequences of failed Potentially Exempt Transfers (PETs) or Lifetime Chargeable Transfers (LCTs)?

Lifetime exemptions and reliefs benefit a taxpayer by reducing the potential IHT liability. In the case of failed PETs or LCTs:

• A failed PET or LCT can give rise to an IHT charge. Provisions that exempt or reduce the chargeable value of the transfer result in a smaller tax bill.

• If the value of a PET/LCT is not high enough to trigger its own IHT charge and the donor dies within 7 years, the chargeable value of the transfer affects the Nil Rate Band (NRB) available for the death estate. Steps reducing the chargeable value of lifetime transfers leave a larger NRB, helping reduce the IHT liability on the death estate.

What are the statutory exemptions and reliefs listed in the information that are available for a person during their lifetime?

The statutory exemptions and reliefs listed below are available for a person during their lifetime:

• Available for lifetime transfers only: • Annual exemption • Family maintenance exemption • Small gifts exemption • Marriage exemption • Normal expenditure out of income exemption

• Available for lifetime and death transfers: • Spouse exemption • Charity exemption • Agricultural Property Relief (APR) • Business Property Relief (BPR)

What is the purpose of the Annual Exemption (AE), and what advice should clients be given regarding its utilization?

The Annual Exemption (AE) allows individuals to make gifts of up to £3,000 each tax year free from IHT. Clients should be advised to:

• Use the AE each year to make gifts without IHT consequences, even if the client cannot give away a large amount in one go.

• Appreciate that consistent giving over a number of years can enable a significant amount of money to be given away.

• Use the AE after any other available exemption or relief is applied to ensure the AE is available for later transfers.

What is the purpose of the Family Maintenance relief, and what considerations should be taken into account when applying this relief?

Family Maintenance relief applies to transfers of value for the purpose of education (of the donor's children) or maintaining dependent family members. It has no upper limit, making it useful for high net worth clients dealing with education and nursing care costs. Considerations include identifying whether the relief applies, ensuring gifts are reasonable in the circumstances, and evaluating the appropriateness of claiming the relief based on the donee's age and existing assets.

What is the Small Gifts exemption, and how can it be used by clients with multiple potential beneficiaries?

The Small Gifts exemption allows individuals to make yearly transfers of up to £250 per recipient free from tax. It cannot be used with the Annual Exemption (AE). This exemption is useful for clients with numerous potential beneficiaries, such as a large family, who want to make gifts to multiple individuals. It is often utilized for occasions like Christmas or birthday presents.

What is the purpose of the Marriage exemption, and how does the amount of relief vary based on the relationship with the donee?

The Marriage exemption allows tax-free gifts of £5,000, £2,500, or £1,000 depending on the relationship with the donee. It can be used in conjunction with the Annual Exemption. This exemption is relevant for clients with planned marriages, providing an opportunity for tax planning and making exempt gifts that might not otherwise be possible.

Explain the Normal Expenditure out of Income exemption, and what considerations should clients keep in mind when utilizing this relief?

The Normal Expenditure out of Income exemption applies to regular payments of spare income that do not affect the donor's standard of living. There is no upper limit to this exemption. It is most useful for clients with a large income where a significant amount goes unused each month. Clients should keep a log of payments to provide proof for HMRC, especially for payments related to life policies in trust, which might otherwise be treated as potentially exempt transfers (PETs).

Summarize the key aspects of the Spouse exemption, including its benefits, considerations, and potential opportunities for CGT planning.

The Spouse exemption fully exempts all transfers between spouses/civil partners, with no limit when the donor is UK domiciled. Benefits include the ability for a couple to make more exempt transfers collectively. Considerations include trust and control dynamics within a marriage. Spouse exemption also provides CGT planning opportunities, allowing assets to be transferred as "no gain and no loss" transfers for CGT purposes, deferring CGT until the donee spouse disposes of the asset.

Explain the Charity exemption, outlining its key features and considerations for clients.

The Charity exemption fully exempts all transfers to charity, with no limit on the amount that can be claimed. Clients should be advised that they can make tax-free gifts to charity, and while very large gifts may be an option for wealthy clients, it's important for them to assess their ability to provide for their family alongside charitable giving. Additionally, leaving 10% or more of the net estate to charity in a will may qualify for a reduced IHT rate of 36% instead of 40%.

Recap the key points of Business & Agricultural Property Relief (BPR/APR), and provide guidance on their strategic use.

BPR and APR exempt transfers of qualifying business/agricultural assets up to either 100% or 50%, provided the transferor has owned the assets for the minimum qualifying period. Care should be taken to ensure that nothing compromises the qualification of existing properties. Clients may choose to invest in qualifying assets or purchase AIM shares for potential BPR benefits. When giving away assets, it's more efficient to give items qualifying for BPR/APR to a non-exempt beneficiary or a trust rather than to a spouse, especially if spouse exemption applies in any event.

What assets are not subject to Inheritance Tax (IHT)?

• Discretionary pension lump sum payments

• Life insurance policies written in trust

How can clients minimize IHT through life insurance and pensions?

• Take out life insurance and/or pay into a pension.

• Write the benefits of life insurance and pensions in trust.

What should solicitors advise regarding existing insurance or pensions?

• Solicitors should advise on the terms of any lump sum payments.

• Identify whether death benefits have been nominated for a third party.

• Encourage clients to nominate death benefits for a third party if not already done.

What happens if a life policy is written in trust after its setup?

There is a deemed PET of the redemption value of the policy at that date.

How is a client treated if they pay premiums on a life policy nominated for another person?

• Treated as making a PET of the annual premiums.

• Normal expenditure from income relief can be claimed to mitigate this.

Why is it worth considering making PETs or LCTs even without reliefs or exemptions?

• The donor's estate becomes smaller, reducing potential IHT on their death.

• Tax planning can involve giving away money or assets via PETs or LCTs.

What should be considered in tax planning involving gifts?

• Ensure the client has sufficient capital to make the gift.

• Understand that once the gift is made, it's impossible to recover the money without the beneficiary's consent.

What is the key feature of a Potentially Exempt Transfer (PET)?

There is no charge at the time the PET is made so a client can give away significant sums of money, and provided the donor survives 7 years, the transfer will become fully exempt.

What risk is associated with making a PET, and how can it be mitigated?

• The risk is not knowing for certain if the client will survive 7 years.

• Mitigate the risk by taking out fixed term life assurance to cover the potential IHT on the PET.

How does fixed term life assurance work in relation to a PET?

• Pays out a lump sum if the donor dies within 7 years after the transfer.

• Cost depends on the life expectancy of the client.

How is IHT charged following the death of the donor after a PET?

• IHT is charged on the chargeable value of the PET at the time it was made, not the date of death value.

• Clients should consider giving away assets likely to increase in value over time.

What is the tax treatment of a PET for CGT purposes?

• A PET will usually be a disposal for CGT purposes.

• Normal rules apply unless hold-over relief is available.

What is the parental settlement rule in the context of making a gift to an unmarried minor child?

• Income arising from the property given away is taxed as if it still belongs to the parent.

• This rule applies if the income is more than £100.

What is the key feature of a Chargeable Lifetime Transfer (LCT)?

• A gift into trust is immediately chargeable to IHT.

How is the IHT reassessed if the donor dies within 7 years of making an LCT?

If the donor dies within 7 years of making the LCT, it is reassessed at the death rate.

What is the purpose of using trusts for tax planning with LCTs?

• Useful where a client can afford to make a substantial gift but wants to benefit a group of people.

• Can move significant value into trust from the client's personal taxable estate over time.

What are the considerations when drafting a will for IHT planning?

• Exempt beneficiaries & qualifying assets (focus of this element).

• Allocation of exemptions.

• Nil rate band.

• Trusts.

Who are the exempt beneficiaries for IHT purposes when a person dies?

• Spouse / civil partner of the deceased.

• Charities.

How should a client be made aware of the exempt status of beneficiaries when drafting a will?

The client should be made aware of the exempt status of the spouse / civil partner and charities, as this may impact on the drafting of their will.

Are the rules that apply to spouses and marriage equally applicable to civil partners and civil partnerships?

Yes, all rules that apply to spouses and marriage apply equally to civil partners and civil partnerships.

Why is it tax-efficient for a client to leave assets to their spouse or civil partner by will?

All gifts to a spouse are exempt from Inheritance Tax (IHT).

What does the spouse exemption relief apply to in the context of gifts?

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

What is the percentage of relief for the value of items inherited by the surviving spouse under the spouse exemption?

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

When does spouse exemption offer a tax saving?

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

What advice can be given to unmarried couples regarding spouse exemption?

• It may be appropriate to discuss the benefits of spouse exemption.

• "Getting married" may be the best tax planning advice they can be given.

What should a client understand about the benefit of spouse exemption on death?

The benefit of spouse exemption on death is lost if the client is no longer married at that date.

What additional consideration is mentioned regarding the application of spouse exemption for couples where one is domiciled outside of the UK?

If either one of the married couple is domiciled outside of the UK, the application of spouse exemption is more limited, and specific advice is needed.

Why is it tax-efficient for a client to leave assets to a qualifying charity by will?

• Gifts to a qualifying charity by will are exempt from Inheritance Tax (IHT).

What does charity exemption relief apply to in the context of gifts?

Charity exemption relief applies to specific gifts and to the gift of residue.

What is the significance of leaving 10% or more of the net estate to charity in terms of IHT?

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%.

How can the testator increase the amount of a charitable gift without reducing the amount the non-exempt beneficiary receives after tax is paid?

• In some situations, the testator can increase the amount of a charitable gift without reducing the amount the non-exempt beneficiary receives after tax is paid. The increase in the legacy amount is offset by the tax saving made by the lower tax rate.

What are the two main types of assets that may qualify for Inheritance Tax relief?

• Business Property.

• Agricultural Property.

What is the minimum ownership period for assets to qualify for Business Property Relief (BPR)?

Qualifying assets must have been owned by the deceased for a minimum of 2 years prior to death.

What is the minimum ownership period for assets to qualify for Agricultural Property Relief (APR)?

Qualifying assets must have been owned by the deceased for the minimum period of time prior to death, usually 2 years.

When must a client own qualifying assets for the relief to apply?

• A client must own qualifying assets at the date of their death (not the date of their will) for the relief to apply.

What is the main risk mentioned regarding qualifying assets for Inheritance Tax relief?

The main risk is that the client sells the assets before death.

Are specific tax planning considerations required regarding the structure of the will for assets with Inheritance Tax relief?

No specific tax planning is required regarding the structure of the will provided there are no exempt beneficiaries.

Where does most tax planning regarding the gift of qualifying assets by will occur?

Most tax planning regarding the gift of qualifying assets by will occurs where clients with these assets want to leave part of their estate to exempt beneficiaries, such as a spouse and/or charity.

What is the primary concern when the beneficiary exemption interacts with asset relief regarding wills?

The primary concern is usually to make full use of both the beneficiary exemption and the asset relief.

How is the interaction between beneficiary exemption and asset relief complicated in the context of specific gifts?

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

Provide an example of a tax-inefficient specific gift of qualifying assets to an exempt beneficiary.

Example: "I give my shares in X Ltd to my spouse." In this case, both spouse exemption and BPR apply in relation to the same gift, wasting BPR and losing an opportunity for the testator to make more tax-free gifts to non-exempt beneficiaries.

Why should a client be advised against making specific gifts of qualifying assets to exempt beneficiaries from a tax planning perspective?

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

What is a possible solution for a testator who wants their spouse to inherit qualifying assets despite the potential tax inefficiency?

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.

What is the benefit of naming the testator's spouse as one of the trust beneficiaries in the case of a discretionary trust?

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.

What happens if qualifying assets fall into the residuary estate and are not specifically given away?

If qualifying assets fall into the residuary estate and are not specifically given away, APR/BPR do not attach to the assets.

What occurs when apportionment allocates some/all of the relief to an exempt beneficiary?

APR/BPR are wasted when apportionment allocates some/all of the relief to an exempt beneficiary.

In what situations do APR/BPR become wasted in apportionment?

• APR/BPR become wasted in apportionment when either all or part of the residuary estate (containing qualifying assets) passes to an exempt beneficiary, commonly the testator’s spouse.

• APR/BPR also become wasted if 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).

What is the simple objective of inheritance tax (IHT) planning by will?

The simple objective of IHT planning by will is to minimize the tax liability on a person’s death to ensure the greatest provision for their surviving family.

What are the considerations when drafting a will with IHT planning in mind?

• Nil rate band.

• Exempt assets and beneficiaries.

• Trusts.

• Allocation of exemptions and reliefs (focus of this element).

What do the statutory rules ensure in the situation of taxable estates with exempt beneficiaries?

Statutory rules ensure that an exempt beneficiary is not taxed on their gift.

How can the effect of statutory rules vary depending on the will's drafting?

The effect of statutory rules can vary depending on how the will has been drafted.

Are there particular issues for estates where no IHT is payable or where IHT is payable to chargeable beneficiaries?

No, there are no particular issues 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 the testator states otherwise).

What determines the allocation of exemptions in the context of exempt beneficiaries?

Statutory rules determine the allocation of exemptions, and express wording within the will can affect the way in which the IHT is calculated.

In a scenario where a testator makes a will with a specific gift to an exempt beneficiary and the residue to a chargeable beneficiary, what is subject to IHT?

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

In a scenario with a specific gift to an exempt beneficiary and the residue going to both chargeable and exempt beneficiaries, what is subject to IHT?

Only part of the residue is subject to IHT, and IHT is calculated on the children’s share and paid from this amount.

In a scenario with a specific gift to a chargeable beneficiary (subject to tax) and the residue to an exempt beneficiary, what is the only part of the estate subject to IHT?

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

In a scenario with a specific gift to a chargeable beneficiary (subject to tax) and both chargeable and exempt beneficiaries in the residue, how is IHT due apportioned?

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

In a scenario with a specific gift to a chargeable beneficiary (free of tax) and the residue to an exempt beneficiary, how is the true value of the gift calculated?

The true value of the gift is calculated by grossing-up, which is outside the scope of the module.

What does "using" the Nil Rate Band (NRB) on death refer to?

"Using" the NRB on death refers to making transfers to non-exempt beneficiaries, which are taxed at 0% on the value that falls within the NRB.

In what situations is the NRB used in full?

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

If a married testator wants to leave assets to their surviving spouse, what options do they have regarding the use of their NRB?

A married testator who wants to leave assets to their surviving spouse may choose to either leave their whole estate to their spouse (using none of the NRB) or make gifts to non-exempt beneficiaries and give the remainder to their spouse, using the NRB in whole or part depending on the value of the gifts to non-exempt beneficiaries.

In the context of couples with children, what is a common objective for tax planning in wills?

In the context of couples with children, a common objective for tax planning in wills is often to reduce the IHT burden for the family as a whole, maximizing the amount that can pass down a generation to children or grandchildren.

What was the situation regarding the transferability of the Nil Rate Band (NRB) between spouses prior to 2007?

Prior to 2007, it was not possible for one spouse to pass on their NRB to the survivor, and to the extent a testator’s NRB was not used on their death, it was wasted.

What issue arose when a will left everything to a spouse before the introduction of NRB transferability?

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

Why is it no longer crucial to ensure the first of a married couple to die makes use of their Nil Rate Band (NRB)?

It is 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.

In what situations might a client want to use their NRB and not leave everything to the survivor?

A client may want to use their NRB and not leave everything to the survivor 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.

• There is an advantage to keeping the survivor’s estate smaller for reasons such as reducing the value of assets within the remit of local authority assessment for care home costs or 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.

Why might unmarried couples be concerned with 'bunching' in terms of Inheritance Tax (IHT)?

Unmarried couples might be concerned with 'bunching' in terms of Inheritance Tax (IHT) because if both parties have estates large enough to attract IHT, tax will be payable on the first and second deaths (unless other exemptions apply), and the value of the assets inherited from the first to die may be re-taxed as part of the survivor's estate before passing to their children.

What is one option for unmarried couples to limit the amount the survivor inherits and avoid 'bunching'?

One option for unmarried couples to limit the amount the survivor inherits and avoid 'bunching' is for the first of a couple to die to leave an amount into a discretionary trust instead of to the survivor directly.

What might be a tax planning strategy for unmarried couples where one has an estate worth less than the Nil Rate Band (NRB)?

A tax planning strategy for unmarried couples where one has an estate worth less than the Nil Rate Band (NRB) might involve the richer of the two making transfers during their lifetime to equalize the value of the two estates, and then each person making wills that benefit the other.

What are the criteria for claiming the Residence Nil Rate Band (RNRB)?

The criteria for claiming the Residence Nil Rate Band (RNRB) include having a qualifying residential interest, leaving it absolutely to a lineal descendant (children, grandchildren, etc.), and the NRB being reduced (tapered) for estates worth more than £2M.

Why is it not advisable to specify a fixed sum when giving away 'the NRB' to a non-exempt beneficiary?

If the testator does not have a full NRB available at the time of their death, part or all of the gift may become taxable unintentionally. Additionally, the NRB amount may change over time, leading to a missed opportunity to utilize the tax-free amount.

What is the drawback of using a fixed sum in a gift clause, such as "I give the sum of £325,000 to my daughter"?

The fixed sum approach may result in unintended taxation if the testator's NRB is not fully available at the time of death. Changes in the NRB between the date of the will and the date of death can also lead to missed opportunities for full use of the tax-free amount

What is a recommended alternative to specifying a fixed sum in a gift clause involving 'the NRB'?

A formula clause, such as "I give as much of my nil rate band as is available to my daughter," is usually preferred. It provides flexibility and avoids the risk of unintended taxation due to changes in the NRB.

Why is certainty important when using a formula clause for 'the NRB' in a gift clause?

Certainty is crucial because formula clauses may or may not include specific details, such as the NRB transferred from a pre-deceased spouse or the Residential Nil Rate Band (RNRB) and any transferred RNRB. Clarity ensures the intended coverage of all relevant NRB amounts.

How does a testator's preference for maximizing the use of their NRB impact the choice of a gift clause?

A testator aiming to maximize the use of their NRB, often before paying the residue to their spouse, would prefer a clause covering all possible NRB amounts. In contrast, a testator wishing to cap the maximum amount given to the beneficiary might choose a different clause.

How can a testator make a gift into a trust through their will?

A testator can make a gift into a trust by including specific provisions in their will.

What is the legal status of a trust in terms of separate legal personality?

A trust does not have separate legal personality; a gift into trust acts as a transfer to the trustees, who become legal owners of the assets forming the trust fund.

What are the roles of the trustees and beneficiaries in a trust created by a testator?

Trustees are the legal owners of the trust fund, while beneficiaries hold equitable and beneficial interests in the assets.

What options does a testator have when making a gift to a trust?

A 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.

How can a testator add assets to an existing trust, and what is the common approach?

Assets can be added to an existing trust by identifying the trust in the will. However, it is more common for a new trust to come into existence through the terms of the testator's will.

What type of clause in a will creates a new trust, and what should follow such a clause?

A clause like "I give the sum of £325,000 to my Trustees to hold on trust" creates a new trust, and subsequent clauses in the will should contain detailed provisions.

Is it common for the same individuals to serve as both executors and trustees in a testator's will?

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

How does a will that adds to an existing trust differ from one creating a new trust?

A will that adds to an existing trust, as seen in a clause like "I give my Residuary Estate to the trustees of the ABC Family Settlement," does not require further detailed clauses.

What is the term for a trust created on death by a testator's will, and what are the key elements involved?

A trust created on death by a testator's will is termed a 'will trust.' The will serves as the trust deed, the testator is the settlor, and the trust comes into existence on the date of the testator's death when the provisions of the will become operative.

What complexities are involved in drafting a will that creates a trust, and what does it require?

Drafting a will creating a trust can be complicated. Express wording in the will is required to set out the terms of the trust, appoint trustees, identify beneficiaries, specify the estate part under the trust, and define the scope of the trustees' powers.