Recent case highlights issues that might be relevant to our clients who are part of step-families
We recently advised a widow whose husband died last year. The husband had made some provision for his wife in the Will, but had left the majority of his estate to his adult children from an earlier relationship. The husband’s estate was substantial so his decision about ‘who should have what’ had huge consequences, both in practical terms and in relation to tax; for inheritance tax purposes, anything left to a spouse on death is exempt (so taxed at 0%) but anything left to children is non-exempt and the usual inheritance tax (IHT) rate of 40% applies.
When the step-children realised that they were facing a hefty IHT bill, they took advice from another firm about ways to mitigate this. There is a strange quirk in succession law that allows the beneficiaries of an estate to agree to change the terms of the Will, even where the Will is valid. If this agreement to change the terms of the Will is formalised in a Deed of Variation within two years of death, then HMRC agrees that the estate may be taxed to IHT as if the Will had included the agreed changes (rather than as if it had remained in its original form).
Our client’s step-children signed a Deed of Variation to change the terms of their father’s Will to give a greater share of their father’s estate to their step-mother. This reduced the IHT bill by increasing the share of the estate that would qualify for the spousal exemption. The step-children of course took advice on how best to ensure that their own position was protected, and we advised our client on how to ensure that the arrangement is tax mitigation, not tax avoidance. The desire to make tax savings has to be balanced against the need to be fair to all parties. The children have ensured that this arrangement is mutually beneficial by giving extra to their step-mother now, but subject to trust provisions that direct where the trust money will go on her death.
Trusts of this kind (‘property protection trusts’) are common in Wills where there is a second marriage; it is a way of leaving part of the estate to the spouse while they are living (so that they can take from the trust fund if they need to), but ensuring that the majority of the trust fund will end up with the children. Trusts of this kind offer enormous practical advantages, whilst also enjoying tax advantages because they qualify for IHT spousal exemption. One potential drawback is that children from an earlier relationship might have to wait to receive their inheritance from mum or dad until their step-parent has also passed away, but where there is a large tax advantage to be enjoyed, trusts can be an attractive idea for some families.
If you have any questions about inheritance tax, Deeds of Variation or Property Protection Trusts and how they may apply to you, please call 01458 850146.