Trusts are still a good way to keep the taxman at bay

A landmark ruling has left thousands of couples worried that their discretionary trusts are worthless and that a large chunk of their estate could now be swallowed up by inheritance tax.

However, there are still ways to protect your hard-earned money despite this setback.
The recent ruling by the tax commissioners that a couple’s discretionary trust is invalid because the wife didn’t work and so didn’t contribute to the family wealth has been described as archaic and totally out of step with other areas of law and modern attitudes towards women.

The case involved Oxford University academic Dr Patrick Phizackerley and his wife Mary. Like half a million other couples they set up a trust to ensure that as much of their wealth as possible would pass on to their children instead of going to the taxman. The move is quite common because of the way the current system works.

The threshold at which inheritance tax is payable is currently £300,000. Tax is then payable at 40% on the remainder of the estate. A husband or wife can leave their estate to their surviving spouse without any inheritance tax liability. However, when the surviving spouse dies, the tax then becomes payable by their children or other beneficiaries of their will. The problem has become more acute in recent years as rising house prices mean that four out of ten homes are now above the inheritance tax threshold.

The way for couples to reduce this burden is for both husband and wife to make full use of their allowances by setting up a nil-rate band discretionary trust. This enables them to effectively raise the tax threshold to £600,000.
This is how it works. When the couple make their wills, instead of leaving everything to each other, they each arrange for their share of their assets up to the threshold figure of £300,000 to pass into a trust for their heirs. The remaining spouse would then be able to continue living in the family home but would owe the trust the £300,000. It’s a kind of I.O.U. to their children.

When the remaining spouse dies, the trust calls in the loan which is deducted from the estate and then passes on to the couple’s heirs free of inheritance tax.

The system has worked well but has now been called into question by the tax commissioners’ ruling in the Phizackerley case. Mrs Phizackerley died in 2000 and left her share in the family home in a trust. Her husband was able to continue living in the house. However, when he died in 2002, the Revenue claimed the arrangement was invalid and the estate would be liable for inheritance tax after all.

The problem, according to the commissioners, was that Mrs Phizackerley had not worked during the marriage and so had not contributed towards the cost of the house and therefore the value that she had gifted to the trust.

The ruling seems out of step with the law’s attitude to women in other areas. For example, in divorce cases there is a general presumption that a couple’s assets should be divided equally even if one didn’t work during the marriage. The sense of injustice is made worse by the fact that had Mr Phizackerley been the first to die then the problem would not have arisen, the discretionary trust would have done its business and there would be no inheritance tax to pay.
The Phizackerley family say they don’t intend to appeal but most commentators believe there would be a good chance of a successful legal challenge. Whether or not that happens remains to be seen but in the meantime, couples should not be alarmed into thinking that such trusts are not worthwhile.

The difficulties encountered in this particular case would only affect a limited number of people, especially if the trusts are properly set up. When a potential problem does arise, there are still measures that could be taken. For example, on the first death, the surviving spouse could consider a Deed of Variation to pass some of their wealth on to their children or an alternative chosen beneficiary. This would reduce the value of their own estate and so reduce the amount of inheritance tax payable on their death.

Of course, the surviving spouse may need to put safeguards in place to make sure they are not disadvantaged by taking such measures.

The issues are complicated and it is important to get good professional advice. The important thing at this stage is to ensure people are not put off using discretionary trusts because they still have a major role to play in mitigating against inheritance tax.

For more information on trusts please contact Peter Sutherland.

TV actor challenges his late wife’s will

Actor Nigel Havers, perhaps best known for his role in the TV series The Charmer, has successfully challenged his late wife’s will and won a large settlement after a legal battle with his two stepsons.

Mr Havers took legal action claiming that he had not been left “reasonable financial provision” and wasn’t getting a fair share of his wife’s £2.3m estate.

The case was due to go to court but a compromise agreement was reached shortly before proceedings were to begin. He will receive £375,000 with £235,000 going to his two stepsons. The actor will be able to use the estate to buy property for his personal use, but on his death it will be inherited by the two stepsons.

The Havers case reflects a growing trend in which second marriages lead to disputes over wills. Both he and his late wife had been married before.

Conflicts due to relationships started later in life have now become one of the main reasons for families taking legal action if they feel they’ve missed out on their rightful inheritance following the death of a relative.

The example of the Havers situation is quite common with one spouse leaving most of their estate to their children from a previous relationship. The surviving spouse feels they haven’t been fairly treated and challenge the will.
The problem also occurs the other way round when a person leaves most of their wealth to their spouse and very little to the children of their first marriage. Those children may well be adults in their thirties and forties who feel they’ve missed out on their rightful inheritance.

We also have cases in which a will ignores someone like a son or daughter who expects to inherit but gives no explanation as to why that person has missed out.

Many of these problems could be avoided if people made their intentions clear when drafting their will.
If you want to exclude someone who might otherwise expect to inherit then it’s best to explain why you want to do that. A statement of wishes placed with the will may help avoid any potential disputes. It is best to get good legal advice from a qualified solicitor when drawing up a will to ensure it properly reflects your wishes and is legally sound. That should prevent most problems arising.

However, if problems do occur then anyone wanting to challenge a will must do so within six months of probate being granted.

We are happy to provide expert advice on all matters to do with wills and probate to make your will please contact Peter Sutherland.