Can an estate be diverted to someone else?

Read time: about 8 – 10 mins

A wife (W) has died, leaving her entire estate of £700,000 to her husband (H), which includes the family home and a rental property from which she received an income. However, H believes that W would have preferred to leave her estate to her childhood friend (F). H is trustee and executor of W’s will so what options could he use, in his capacity as beneficiary of W’s will, to divert the estate to F?

First of all, caution should be exercised by the adviser here: a full understanding of the circumstances surrounding the matter is required.

We would need to satisfy ourselves that H wishes to give the gift freely and is not under any undue influence from F and that he has the requisite mental capacity to gift the assets.

An understanding of why H believes that W had wished to gift the asset should also be considered as well as knowledge of the circumstances in which W’s will was drafted.[1] Any letter of wishes or other accompanying documents should also be taken into account to obtain a clear understanding of H’s motivation.

Financial advice would clearly need to be sought by H. Consideration should also be given as to whether he is likely to require care from the local authority in the not too distant future.[2]

Should the adviser be satisfied that H has the ability to make the gift, having taken all the circumstances into account, then the following options would be available to H as beneficiary:

Deed of Variation

1) An absolute gift of assets held in the wife’s sole name

H can vary the provisions of W’s will at any time. If H signs an instrument of variation within two years of W’s death, then special tax treatment of the disposal should apply so that any disposal is treated as being a disposal directly from the deceased rather than the donor of the gift.[3]

Such a variation could include some or all of the assets that H is due to inherit from his late wife’s estate.

The benefits of a deed of variation are that H can direct to whom W’s estate will pass.

The negative impact of a gift by variation however would not only be the financial consequences for H (since his estate would be greatly reduced by the gift) but this could also have several negative consequences for tax purposes both for H and F.

Under the present arrangement, all W’s assets will pass to H free of inheritance tax regardless of the value, assuming that they are both UK domiciled. H’s estate will also be able to benefit from W’s transferable nil rate band (providing it has not been used up in her lifetime) and benefit from W’s unused residence nil rate band, assuming the property on his death passes to direct descendants and their joint estates are not over £2 million, in which case the residence nil rate band element is reduced by £1 for every £2 above the threshold.[4]

Should H wish to direct any portion of his beneficial interest to F, his transferable nil rate band will be eaten into and his estate will have a percentage available allowance depending on the value of the gift that has been passed to him.[5] Depending on the value of the gift, there might also be an immediate charge to inheritance tax.

Any gift through a deed of variation though, as long as H reserves no benefit from it once gifted, will reduce H’s taxable estate accordingly.

2) An absolute gift of assets passing by survivorship to the husband

Should H have inherited any assets through survivorship then he will be able to sever the joint tenancy post death and redirect W’s share of the asset to F should he wish.

If the family home was held as joint tenants and H severs the joint tenancy so that it is held as tenants in common and then gifts a half share (or other portion) to F he should consider this position carefully. If H wanted to sell the property, then he would need to have F’s consent. Problems can also arise between joint owners as far as maintenance of the property is concerned. If H wants to proceed with this option then a Declaration of Trust outlining the duties and responsibilities of the owners of the property in detail would be advisable. Separate legal advice would need to be sought by each party.[6]

If there is a charge on the property, then consent from the lender might be required for any change in ownership and it might be a requirement for F to become party to the mortgage.

In addition, the same impact for inheritance tax purposes will apply here where assets are passing to F as a non-exempt beneficiary.

There might also be capital gains tax implications on a disposal of the family home on F’s share if it is a second home for him.

3) A variation onto discretionary trust

H can opt to settle some or all of W’s estate onto discretionary trust through an instrument of variation.

In this case the Trustees would exercise their discretion over the trust assets, but discretionary payments of income or capital could be paid to a number of potential beneficiaries.

Here, both F and H could be potential beneficiaries as well as any other relevant beneficiaries perhaps as outlined in W’s will.

The flexibility of this arrangement could be beneficial for all parties since it might provide H with some financial security should he need it in the future and F with some benefit if this is in accordance with W’s wishes, subject to Trustees’ agreement to make distributions.

Inheritance tax will be payable on trust assets over the nil rate band and exit charges will apply.

It is unlikely to be desirable for H for the family home to be put into discretionary trust since the Trustees would need to exercise their discretion in relation to H’s occupation of it. If he wishes to continue to reside there then a market rent should be payable in relation to the portion held in the discretionary trust otherwise it risks being treated as a sham.[7]

It may however be favourable for H to consider this option for some of the assets. The same IHT treatment will apply for H’s estate in that it will affect his estate’s available transferable nil rate band, but the trust assets should be outside of his estate for IHT purposes on his death.

On trust income over £1,000 the trust assets will be charged at 38.1% on dividend income and at 45% on all other income which is pertinent for the income that will be received from the rental property[8].

Capital gains tax will also apply to trust assets, but holdover relief should be available.

4) A variation onto a life interest

Another option would be for H to vary his entitlement so that it passes onto a life interest for him with the future capital interest passing to F.

In this scenario H would be entitled to the income from the trust for life and would be able to benefit from any interest or dividends from cash savings as well as the income from the rental property. On H’s death the capital value would pass to F.

For IHT purposes the value of the life interest would be aggregated with H’s free estate but his estate would be entitled to benefit from any available transferable nil rate band (and RNRB if applicable) on death.

This type of trust is more rigid, and the default position is for income only payments to be made to H[9]. It may however mean that the capital value of the trust would not be taken into account as far as his financial assessment is concerned should he have the need for care in the future.[10]

An ability to distribute capital to H during his lifetime (or to F) could be included in the trust instrument to allow more financial flexibility for the beneficiaries but any capital payments would be subject to the Trustees’ agreement.

The income tax position would be more favourable here as dividend income will be taxed at 7.5% and all other income at 20%[11].

If there is a lifetime termination of the interest then it will be treated as a potentially exempt transfer (‘PET’) (see below) and CGT may apply.

Lifetime gift

As mentioned above, any gifts through variation passing to non-exempt beneficiaries will affect the amount of transferable nil-rate band available for H’s estate and might incur an immediate IHT liability. H could consider making a lifetime gift of assets passing to him from W’s estate to F.

This would be treated as a PET for inheritance tax purposes and therefore he would need to have survived seven years from the date of the gift for its value to be outside of his estate for inheritance tax purposes[12]. Reducing rates apply where H has survived the gift for between four and seven years.

Any gift over the nil rate band through variation would create an immediate liability to inheritance tax which a lifetime gift by H could avoid.

It should be ensured that no benefit of the gift is reserved by H to ensure that his estate is reduced for IHT.[13]

Disclaim

H could disclaim a gift due to him under W’s will.[14] But it is not possible to disclaim in favour of someone i.e. to re-direct the gift so if H disclaims any part of his inheritance then it will pass in accordance with the next entitled under the will or the intestacy rules.[15] If F was the next entitled under the provisions of W’s will then this might satisfy H’s wishes to surrender the entire estate. If this is not the case, then this course of action will not meet H’s objectives.

It should be noted that H cannot disclaim W’s share of property passing to him by survivorship and any joint tenancy cannot be severed by H post-death so that he can disclaim.

Should H choose to disclaim his share of the estate passing to him from W then there would be an immediate inheritance tax charge payable, subject to any applicable reliefs.

Will

It may be that H’s objectives could be achieved by a gift in his will to F. An understanding of his circumstances would be required to take into account any competing claims under the Inheritance (Provision for Family and Dependents) Act 1975.

Such a gift would not have the same negative impact on his transferable nil rate band, nor would it incur an immediate IHT charge on W’s death. Furthermore, it would allow H financial security for his lifetime, but it would mean that F’s beneficial entitlement would be postponed until H’s death.

Notes:

[1] A Larke v Nugus ([2000] WTLR 1033) letter may be required

[2] See Care Act 2014 and deliberate deprivation rules

[3] S142 Inheritance Tax Act 1984 and s62 Taxation of Chargeable Gains Act 1992

[4] Sections 8D-M and s18 of the Inheritance Tax Act 1984

[5] Finance Act 2008 Schedule 4

[6] Solicitors Regulation Authority Code of Conduct Version 21 Chapter 3 and 4

[7] Rahman v Chase Bank Trust Co (CI) Ltd. (1991) JLR 103

[8] See Finance Act 2019 and Income Tax Act 2007

[9] Statutory powers of advancement will apply, subject to contrary provision in the trust instrument

[10] This might also be applicable to some of the other options listed

[11] See Finance Act 2019 and Income Tax Act 2007

[12] s3A Inheritance Tax Act 1984

[13] See HMRC Manual IHTM14333

[14] See RE Stratton’s Disclaimer [1958] Ch 42, [1957] 2 All ER 594

[15] re Scott, Widdows v Friends of the Clergy Corporation [1975] 1 WLR 1260 [1975] 2 ALL ER 103