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Tax and trusts: Sideways inheritance

21 February 2019

The incidence of divorce and re-marriage amongst baby-boomers can make inheritance fraught with difficulties and requires talking to clients about their wishes, wills, trusts and tax, says John Humphreys, inheritance tax specialist at WAY Investment Services Ltd

Dealing with inheritance issues can be an extremely sensitive matter. How much to pass on and to whom is not always an easy question to ask, especially when families trees are complex.

Recent figures have shown that although divorce rates are, encouragingly, falling overall, it is more typically millennials that are staying together whilst the baby boomer generation are, sadly, actually splitting up in greater numbers.

Research by The Resolution Foundation in 2017 revealed that the baby boomer generation hold over half of the UK’s £11 trillion wealth, thanks to significant house price inflation, good long-term investment returns and the benefit of final salary pension schemes. This group are also more likely to marry again, which creates an urgent need for discussion and advice about inheritance.

Remarriage means that the majority of the estate will automatically pass to the new spouse, unless a Will states otherwise. This means that children from a previous marriage can suddenly be removed from the natural inheritance line and children from a later marriage, even if no blood relation, may stand to inherit the majority of an estate instead.

Such as a case of ‘Sideways Inheritance’ was famously illustrated through the family of Pink Panther actor Peter Sellers. On his death, almost of all of his multi-million-pound estate passed to his fourth wife, Lynne Frederick. She went on to marry again and had a child. When Lynne Frederick died she left all of her wealth to her daughter. Meanwhile Peter Seller’s three children from previous marriages inherited just £800 each.

It is essential for advice teams to alert clients to the rules as many may rather wish for a more equitable division of their estate between their children. Clients either divorcing or remarrying should first be urged to review and update their Will, and not least make a Will if they haven’t done so already. Financial plans need to work alongside the Will – starting with a review and update of any Pension Scheme and Death-in-Service nomination forms.

Trust arrangements

Families concerned about what the future might hold may wish to consider establishing trust arrangements to safeguard their family wealth. Such planning primarily ensures that assets are passed on to those they are intended to, and only as a secondary consideration may form part of an appropriate strategy to manage an Inheritance Tax liability (IHT).

Making gifts to a flexible reversionary interest trust is one method of ensuring that assets will pass to named beneficiaries, a key advantage being that payments (as reversions) can be made to the settlor, if required, at the discretion of the Trustees. There is no immediate tax charge on gifts up to the value of the nil-rate-band (NRB). Such arrangements can be appropriate for many families to safeguard inheritance for those to whom it is intended. Clients with significant estates can repeat the process every seven years to recycle their NRB.

Another option appropriate for some families are bare trusts, where gifts can be made as Potentially Exempt Transfers (PETs) with no immediate tax charge. However an important point to note is that once beneficiaries reach the age of 18 they obtain full access to the trust, with the age being even lower in Scotland at just 16.

Normal expenditure from Income

Paraplanners should also be clear on the rules regarding normal expenditure from Income. These rules allow an individual to immediately remove ‘surplus’ income from their IHT assessable estate.

In order to qualify for immediate IHT exemption, gifts must follow three rules: firstly, they must be intended to be regular, secondly they must be from surplus taxable income, and thirdly they must not impact on the standard of living of the donor.

Again, if the gifts are made into a flexible reversionary interest trust, the Settlor can retain a degree of access to the assets through reversions, at the discretion of the independent Trustees.

There are two further points that paraplanners should raise with clients setting up trusts.

Firstly, there are notable benefits in choosing independent and professional trustees to manage a trust, not least where the complexities and delicate balances of family relationships come into play.

Secondly, although not legally binding, clients should consider writing a Letter of Wishes for the trustees. Such a document can provide valuable information to the trustees as to how the settlor wishes assets to be managed and distributed during their lifetime and after. As with the Will, it should be also be reviewed and updated regularly and crucially at the point of any divorce or remarriage.

Family life is rarely straightforward, and inheritance is just one issue that can be fraught with difficulties. Advice teams need to be on hand to tackle the challenge, providing solutions that are robust legally and fiscally and that match the wishes of family members. Getting the planning right early can save an awful lot of heartache later on.

First published in the Professional Paraplanner February 2019 issue