Someone leaves you lots of money in a Will and it now means your estate will face an inheritance tax bill when you die. Oops, what do you do?
Do you know how much the Chancellor of the Exchequer is expecting to pocket from Inheritance Tax (IHT) in this financial year? A cool £3.6 billion! And do you know how much he collected in his first year in office in 1997? A mere £1.7 billion.
Much as Gordon Brown keeps insisting that very few people will be liable for Inheritance Tax (IHT) on their estates when they die, there's no doubt that the number is growing. It's expected that 37,000 estates will be liable for IHT this year compared to 15,000 in 1997.
There are two main reasons for this: house prices, which have risen by 179% over the last decade and fiscal drag, which is a fancy term to describe tax thresholds failing to keep pace with inflation. The current IHT threshold - the amount you can leave before your estate becomes liable for tax - is currently £285,000. According to research by the Halifax Bank, if it had gone up in line with house prices over the last ten years, the threshold would be at least £430,000!
It's precisely for this reason that you might want to consider changing a Will if you've inherited sufficient money from someone to make your own estate potentially liable to inheritance tax.
Let's take a classic example: a husband and wife have Wills leaving everything to each other and upon second death, it all goes to their children. Each of them has assets worth, say, £250,000 and, as assets passing between husband and wife are exempt from inheritance tax and, anyway, it's below the IHT threshold, there's no tax worry.
But the husband then dies immediately doubling the amount his wife would leave when she shuffles off to £500,000. Anything over the £285,000 threshold is taxed at 40% so in this case, HM Revenue & Customs could look forward to collecting £86,000 of the remaining £215,000 when she dies. Gulp!
This is where the Deed of Variation comes to the rescue! Also known as a Deed of Family Arrangement, she can use it to, effectively, re-write her husband's Will and divert his money elsewhere. This can be either directly to the children if she doesn't need the funds herself or, if she does, into a discretionary trust where the funds can be used for her own purposes until she dies.
There are three important things to note here. First, the Deed of Variation must be put into effect within two years of the first death. Second, all the beneficiaries of a Will must agree to the Deed of Variation. And third, extra care must be taken with the wording of the Deed where the principal asset is the matrimonial home.
Married couples and civil partners can pre-empt this sort of scenario by setting up a Will Trust scheme before such problems arise. The idea is that both your Wills allow for a discretionary trust to be created on the first death. The assets of the deceased spouse up to the value of the IHT threshold of £285,000 will then automatically be put into the trust with the rest of the estate going to the survivor free of IHT.
Either way, it is imperative that you consult an expert and not just any old lawyer because a Deed of Variation or a Will Trust is not simple. In his efforts to collect even more revenue from those with potential IHT liabilities, the Chancellor has recently changed the tax rules relating to certain trusts so it's a veritable minefield. To that end, make sure you use someone who is a member of the Society of Trust and Estate Practitioners (STEP).
Read the Fool's Wills & Probate Guide for more information and visit our Wills & Probate discussion board.