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A properly drafted Will could save you thousands

Napthens - October 17th 2016

Careful planning and an appropriately drafted Will could reduce the amount of Inheritance Tax (IHT) payable on your death as the following case study demonstrates.

Mr and Mrs Smith are in their mid-50s. They are married with 2 children in their 20s. Their assets are as follows:

  • House valued at £600,000
  • Rental property valued at £200,000
  • Savings/investments of £400,000
  • Mr Smith is a 30% shareholder in ABC Ltd and his shares are valued at £500,000

Mr and Mrs Smith have Wills in place leaving everything to each other when the first of them dies and then equally between their two children when the second of them dies.

Mr Smith dies unexpectedly and his estate passes to Mrs Smith. There is no IHT due as they are married and therefore the estate is eligible for spouse exemption.

In relation to ABC Ltd, there is no shareholders agreement or shareholder protection in place. This means that the shares pass to Mrs Smith as part of Mr Smith’s estate. The surviving shareholders cannot insist on the shares being returned/sold to them furthermore they do not have the funds with which to buy the shares from the estate and consequently Mrs Smith joins the company. This is something neither Mrs Smith nor the other shareholders wanted or envisaged. Eventually Mrs Smith manages to sell the shares on the open market for the sum of £500,000 bringing an unknown shareholder onboard to ABC Ltd.

Mrs Smith dies and her total estate is £1.7 million comprising the house, the rental property, the savings and the sale proceeds for the shares. Mrs Smith has an Inheritance Tax allowance of £650,000 and tax is paid at 40% on any assets over and above the allowance resulting in an Inheritance Tax bill of £420,000.

With proper planning in place, the situation could have been very different.

ABC Ltd is a company which is trading in nature and therefore Business Property Relief is available on the value of the shares. Consequently, upon Mr Smith’s death his shares could have been directed into a Discretionary Trust tax-free which Mrs Smith could benefit from during her lifetime. A shareholders agreement could have ensured the shares remained with the shareholders of ABC Ltd and shareholder protection would have paid ABC Ltd the funds with which to buy the shares from the Trust.

Crucially, this means the shareholders retain control of ABC Ltd and Mr Smith’s estate receives the £500,000 value of the shares.

Furthermore, on Mrs Smith’s death the £500,000 paid for the shares does not add to her estate due to Discretionary Trust incorporated in Mr Smith’s Will. This means that when Mrs Smith dies the Inheritance Tax bill would be just £220,000 resulting in an IHT saving of £200,000.