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Tax Doctor: Power of appointment protects property from IHT issues

Executors of Moira’s estate could prevent her descendants from having to pay an additional £100,000 in inheritance tax by making an appointment of trust property

Tax Doctor: Power of appointment protects property from IHT issues

THE CASE

Moira, who is widowed, has a will that directs her entire estate to a discretionary trust for the benefit of her family. Her estate is worth £1 million, including the family home, which is valued at £600,000.

However, Moira received some advice from a friend that she should change her will and her discretionary trust plans as her children will not be able to make use of the residence nil-rate band (RNRB).

The RNRB, introduced for deaths after 6 April 2017, allows estates above the basic inheritance tax (IHT) threshold (currently £325,000) to claim an additional threshold in respect of a family home before any inheritance tax may be due. This is provided the home (or a share of it) passes to direct descendants of the deceased. The direct descendant of someone is:

  • a child, grandchild or other lineal descendant.
  • a husband, wife or civil partner of a lineal descendant (including their widow, widower or surviving civil partner).

The maximum additional threshold amount is currently £125,000 (for deaths in 2018/19). It is set to rise to £175,000 for 2020/21, before increasing in line with consumer prices index inflation each year thereafter.

THE PRESCRIPTION

What Moira has been told is correct to a point. Even if the beneficiaries are direct descendants of Moira, the RNRB will not ordinarily be available as discretionary beneficiaries are not automatically the beneficial owners of the property.

In the case of Moira’s estate, the lost RNRB could be up to £250,000 if she passed away in the current year, meaning additional IHT of up to £100,000. The £250,000 represents both her and her husband’s available RNRB.

Moira’s executors could use a deed of variation. But this carries practical problems, as all beneficiaries who will be giving up their entitlements need to agree to the variation. This causes particular difficulty as discretionary trusts often include future children and grandchildren as beneficiaries.

Direct appointment

A better option for the executors could be to make an appointment of trust property under section 144 of the 1984 Inheritance Act. The effect of the provision is that the property is treated as if the deceased’s will had stipulated the property passes according to the appointment.

An appointment of Moira’s home to her direct descendant(s) within two years of her death would be treated as though that direct descendant had inherited the property. This would satisfy the requirement for the home to pass to direct descendants under RNRB rules.

On the face of it, it looks like families who had established discretionary trusts on advice of their solicitors and financial advisers could then miss out on an RNRB provision to which they would otherwise be entitled.

No rush, no rash decision

Reviewing estate planning arrangements regularly is good practice. But rushing to dismantle discretionary trust plans to take advantage of a new tax allowance could in fact work against the client’s best interest and estate planning flexibility in the long term.

The discretionary trust still offers great flexibility with the ability for the trustees and executors to take account of the rules at the time of death and the circumstances of those left behind.

Care is needed to ensure trustees are aware of the flexibility. Specialist legal and financial advice is available to them throughout the process of drafting the trusts and on the client’s death.

As always, the most suitable solution will depend on individual client circumstances and objectives.

Charlene Young is technical resources consultant at AJ Bell

Read more: Pension check allows couple to retire to Spain

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