What is Discretionary Will Tax?

Inheritance Tax is a financial blight for many people. As it currently stands (for the 2006-2007 tax year) Inheritance Tax is a duty which must be paid on all estates which total more than £285,000. After this threshold, 40% of the total assets owned by the deceased individual are passed to the Exchequer. Taxable assets include money, property, investments and insurance payouts.

Partners

The vast majority of those people in the UK who are either married or in a civil partnership choose to write their will in such a way that all of their assets are left to their spouse or partner. This seems to most people to make absolute sense; when they die, they wish for their partner to be able, for example, to continue to live in the family home, and to continue to benefit from any savings they may have accumulated. Furthermore, £285,000 seems to many people to be an enormous figure, and one which will be well above the value of their estate. However, this is often not the case.

Continuously rising property prices have meant that a large proportion of the married population of the UK now have joint assets worth well over the £285,000 threshold (also known as the Nil-Rate Band). As a result, an increasingly large number of estates will be eligible for Inheritance Tax. People’s fears about the financial impact of Inheritance Tax are often assuaged by the fact that gifts between partners are exempt; that is, if one partner leaves their entire estate to the other, there will be no Inheritance Tax to pay on the death of the first partner. But what happens when the second partner dies? With an estate of a value great enough to be taxable, the beneficiaries of the second partner’s will are likely to suffer financially.

Some people have chosen to avoid this outcome by passing all of the first partner’s estate directly to the children (who are generally next in line to benefit from a will), rather than to the surviving partner. As each partner legally owns 50% of the total estate, this often brings the amount which is inherited below the Nil-Rate Band. However, the obvious drawback with this course of action is that the surviving partner loses out, and may even be forced out of the family home.

Discretionary Wills

An alternative option is a Discretionary Will. Under this arrangement, each partner’s will stipulates that, on their death, their 50% share of the estate (or £285,000 if the estate totals more than £570,000) will be passed to a trust, which will then make a loan totalling the entire value of the trust to the surviving partner. In this way, the surviving partner maintains their 50% of the estate, as well as having access to the remaining value. When the surviving partner dies, the trust is repaid directly from the remainder of the estate. If the total estate is valued at £570,000 or less, this means that the second partner’s share will fall below the Inheritance Tax threshold. This sum is passed directly to the children without being taxed; similarly, the children also inherit the total value of the trust, which is released on the death of the second partner. In this way, the children will have inherited up to £570,000 tax-free.

Discretionary Wills normally cost more to write than a normal will, but for many people they can mean avoiding large tax bills later. If you are considering this course of action, make sure you take professional advice first.

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