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What is Estate Planning?
Estate Planning is putting in place Wills and Lifetime Trusts to ensure your desired outcome, regarding who benefits from your estate, is achieved. Essentially, this means that the right people get the right money at the right time. It is all about ‘bloodline protection’ as most people want their children and then grandchildren to inherit their money once they die.
There are usually five problems that Estate Planning seeks to address.
- Divorce – Once you leave your money to your children, they could then find themselves getting a divorce. This risks half of your money going to your child’s ex-partner. Given how high the UK divorce rate is, it’s vitally important to protect your money from this scenario.
- Bankruptcy – 80% of small businesses become bankrupt in the first five years. If this were to happen to your daughter or her husband, without careful protection, all the assets that you had left to your daughter could be lost to her creditors or her husband’s creditors.
- Remarriage – Let’s say that upon your death all your assets are left to your married daughter. If she then dies and her widowed husband remarries someone who did not raise your grandchildren, it is highly possible that your grandchildren (against your intentions) could find themselves cut out of the money that you wanted to be left to them.
- Inheriting Early – If a couple were to die early, then their children would inherit at age 18. This means that your grandchildren could find themselves in charge of a large amount of money when they are perhaps not emotionally mature enough to manage it responsibly.
- The 64% Tax – If you don’t deal correctly with your Inheritance Tax problem then on your death you will need to pay a 40% Inheritance Tax charge, with the remainder, in all probability, passing to your children. If they also have an Inheritance Tax problem, then on their death there will be another 40% tax charge on the same money, so in total, this money which goes to your grandchildren will have suffered a 64% tax charge.
So, how do you protect against these problems? There are various solutions which help to protect your assets.
In an ideal world, the best thing to do would be to set up a lifetime trust (a trust established during your lifetime rather than being set up in your will to take effect at your death). In fact, you can set up multiple trusts on different days, rather than each trust being simultaneously created on the same day, that is the day you die. This gives you more flexibility.
Wills, Trusts and Trustees
It is sensible to have both a will and discretionary lifetime trust. When considering who to appoint as trustees, generally speaking, these should be the settlors (the person whose estate is being dealt with) and their adult children as this will reduce costs (you won’t be paying professional trustees). It is also recommended that you appoint one other person who is not a beneficiary of the trust to act as a trustee in the event of a disagreement between your adult children over how the trust should be managed.
How Does All This Work?
How does the solution of setting up wills and lifetime trusts together protect your assets against the five problems listed above? In a normal situation where you don’t have lifetime trusts your Wills might state that you leave your estate to your partner and then, when you are both dead, the Estate gets divided equally between your children. After this, you would hope that the money would travel down the family bloodline, however this might not happen.
Consider the following scenario, Steve and Ann are married and have three adult children: John, Dave and Jane. Now consider each of the five problems in turn and how setting up wills in conjunction with life time trusts can resolve these problems.
By setting up lifetime trusts in conjunction with a will, the desired beneficiaries receive their inheritance in their individual trusts rather than their partners having equal control over the assets. These trusts still lend the money to the adult children’s partners so that they still have the money. This means that they can lend the money interest-free, but it remains recallable on demand by the trustees (who are the adult children and also are the beneficiaries).
Imagine John is married to Mary and then they get divorced. In this case, the trustees recall the loan to John. This prevents Mary from receiving any of the loaned money.
The day after John’s divorce has settled, his other siblings, being the trustees, can give him back the money as a loan (as a part of the loan mechanism).
Imagine again that John and Mary are married. Let’s say that John dies before Mary and, in a few years’ time, Mary marries her golf instructor, Andy. Andy outlives Mary and, as a result, the money that came to Mary through John passes to Andy and, from here to his beneficiaries rather than John and Mary’s children, that is, Steve and Ann’s grandchildren.
In the event of bankruptcy, the creditors cannot get the money because it does not belong to John, it belongs to the trust.
Say John and Mary were to die early, leaving behind their young son. At age 18 he would be able to inherit his parent’s money However, if the money is in a trust, the trustees will decide how much money to give to the grandchild and when to give him the money.
Unfortunately, you cannot avoid paying the initial 40% tax because when the money went into the trust on your death. If it exceeds the allowances then the tax must be paid. However, the money would be protected from your children’s next 40% tax, and any tax the grandchildren would have faced.
Ultimately, this method of Estate Planning can save thousands for a family. Through operating a loan mechanism, the assets are protected from the risks of divorce, remarriage, bankruptcy, early inheritance, and a 64% tax.
Like all matters related to Estate Planning and Inheritance Tax, experienced advice is essential.
Call us if you to book a free consultation to discuss your Inheritance Tax and Estate Planning Issues.