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The perils of intestacy

Dying without a will - ‘intestate’ in legal terminology - means that your estate will pass according to the rules of intestacy. This is certainly not the most tax-efficient way of passing on your assets as it could mean that tax-saving opportunities, such as the benefit of the nil-rate band, may be lost.

The perils of intestacy

Andy Kirby, senior tax and trust manager at law firm Moore Blatch, points out, ‘The importance of a will is not just to make sure that the people you want to receive your assets do so. Equally important is ensuring those that you don’t want to receive your assets don’t.’

It is not the case, as commonly thought, that if a person dies without a will the entire estate will automatically go to their spouse. The reality is that by dying intestate you run the risk of the majority of your personal wealth going to the state.

For example, if you die leaving family members who are financially dependent upon you (such as a spouse or children), the law stipulates who will inherit your estate.

So, the surviving spouse is entitled to £125,000 of the estate free from inheritance tax and a life interest in half the remainder of the estate. The children take the other half of the remainder of the estate and the capital comprising the spouse’s life interest fund when the spouse dies.

However, if you die leaving no dependents at all, the government gets everything – probably not what you want to happen.

Unmarried couples are most at risk of losing property, personal possessions and cash if their partner dies without leaving a will, as current inheritance laws do little to protect new family structures.

The right time to make a will

‘The right time to make a will is as soon as you have assets to dispose of or individuals you want to provide for,’ explains Kirby. ‘There will be certain trigger events that will always mean that you need to consider your will position, such as co-habitation, marriage, divorce, birth of children and grandchildren, or a significant change in your wealth base.’

According to the National Consumer Council, four out of five parents who have not yet made a will are gambling with their children’s future. Should both parents die unexpectedly, the courts may be left to decide who should look after their children.

‘It is important to have a will, even if you feel that you don’t have substantial assets, simply because it will outline the legal guardianship of your children if something happens to both parents,’ advises Julia Whittle, principle at Punter Southall Financial Management.

And, of course, an added benefit to drafting a will is to avoid inheritance tax (IHT). For many this can be a daunting prospect if you don’t know where to start but it needn’t be a complicated or expensive process and could stop the taxman from getting his hands on your estate.

Dealing with IHT

UK residents are liable to pay inheritance tax at 40 per cent on their total worldwide assets, including the value of their property, in excess of the IHT threshold at the time of death – currently £312,000 for the 2008/09 tax year. Figures from the Office of National Statistics show that 4.5 million people in the UK are liable to pay IHT, when both their home and personal wealth is taken into account.

Even though the inheritance tax threshold is raised each year in line with inflation, this has not kept pace with UK house prices, which have, on average, increased by 189 per cent over the last 10 years. Had the IHT nil-rate band increased in line with property price inflation since 1997, the threshold would now stand at £513,850, according to Land Registry figures.

Kate Marsden, marketing director at financial research company Defaqto, says, ‘As UK house prices have continued to outstrip rises in the inheritance tax threshold, more and more households are falling into the inheritance tax net. Advance tax planning is essential if individuals bequeathing assets to their heirs want to reduce the potential inheritance tax bill their beneficiaries will face. Writing a will is a good place to start.’

Taking advantage of the nil-rate band

The basic, most straightforward way of avoiding IHT is to make sure that you are taking advantage of the nil-rate band – the first £312,000 of your estate. Bear in mind that all transfers between husband and wife are exempt from IHT, so no tax has to be paid following the death of the first spouse.

To ensure that you have taken advantage of both nil-rate bands (£624,000), a will can redirect an amount equal to the nil-rate band into trust for your children or another beneficiary.

A discretionary trust fund can combat this problem because, rather than a nil-rate band sum being bestowed on children, the sum is put into a trust fund with specific beneficiaries, including the children and surviving partner. The surviving spouse can also continue to derive an income from assets of the fund without it having an impact on the value of their estate.

‘The main benefit to organising a trust, particularly when children are involved, is one of prudence rather than tax,’ states Andy Kirby. ‘If your estate is substantial, the question you have to ask yourself is do you want your child becoming entitled to substantial assets at the age of 18? My feeling is not, so one of the advantages of trusts for children is that you can defer their entitlement until a specified age.’

Anne Young, tax expert at Scottish Widows argues that trusts should be more popular than they are. ‘Although people may be unsure how they work, they are a relatively straightforward way of helping to reduce, or perhaps set aside a fund to pay for, an IHT bill. People should not automatically dismiss this option, but rather seek professional advice and get a better understanding of the way trusts can help.’

Gifting

Of course, you can always just give your money away. Writing a will allows you to gift your money to your children, beneficiaries and other organisations. A carefully considered and current will means that the people and the charitable causes you care about will benefit. Legacies are an increasingly important source of income for charities and, of course, are exempt from IHT.

But as Young points out, ‘Gifting is becoming an increasingly recognised way to avoid IHT, but remember few gifts are totally exempt. You can give £250 away to an unlimited number of people as well as up to £3,000 per tax year – these will all be exempt. In addition, if you live for seven years after making any other absolute gift, this will be exempt too. As a quarter of the recipients plan to use the money to pay off their own debts, it is likely they could ill afford to pay additional inheritance tax on top.’

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