Why writing a will is top priority in inheritance planning
Along-held tenet of testamentary law in England and Wales is that a testator, being a person completing a will, has the freedom to pass their assets to whom they choose. This admirable arrangement is not replicated in some countries where probate law limits the proportion of one’s estate that can be passed according to the testator’s wishes.
Anyone in this country who does not have a will places their estate at the mercy of rules created by the government, and which are known as the intestacy rules. The perception that applying these rules to one’s estate would give effect to one’s wishes in any event is misguided.
The intestacy rules do not recognise long-term partnerships or cohabiters.
There are circumstances, set out below, by which the intestacy rules would give rise to a distribution of one’s estate which is unlikely to match the individual’s wishes. As well as assets passing into unwanted hands, there could also be a sting in the tail in the form of an avoidable inheritance tax bill.
The intestacy rules do not recognise long-term partnerships or cohabiters. This means that the rights of a long-term partner or cohabiter who has opted against marrying or entering into a civil partnership has no greater claim under the intestacy rules than a short-term partner.
Varying inheritance doe a will
The position becomes increasingly complicated where the couple have children. In these circumstances, the children would inherit the estate of the partner who has passed away. This position could be rectified if the children decide to vary their inheritance so that their surviving parent receives their share.
However, there is no obligation on the child to do so. If the child is under the age 18, they are barred from making this variation.
Where an unmarried couple do not have children, the long-term partner remains empty handed. Instead, the deceased’s parents inherit their child’s estate. The long-term partner would again be reliant on the goodwill of the recipients of the estate, in this case the parents, to vary their inheritance and provide for their child’s long-term partner.
A bereaved spouse or civil partner is in a far stronger position under the intestacy rules compared to a long-term partner.
Should the parents decide that they would prefer to retain their inheritance the bereaved partner would need to bring a claim against the estate, a process that, as well as potentially inciting strife at a delicate time, is likely to be lengthy and expensive while offering no guarantee of success.
Assets passing to one’s parents under the intestacy rules are likely to be inefficient in terms of IHT planning. This is because the assets would be chargeable to IHT in the child’s estate and then again as part of the parent’s estate.
The parent has the option of varying their inheritance to avoid this double taxation of the same assets, but they must do so within two years of their child’s death. Perhaps more saliently, the parent must also have the mental capacity to make the variation.
A bereaved spouse or civil partner is in a far stronger position under the intestacy rules compared to a long-term partner. This is particularly true where the couple does not have any children, in which case the surviving spouse or civil partner inherits everything in their deceased partner’s estate.
As well as reflecting the likely intentions of the deceased, the estate would also benefit from the spousal exemption, meaning there would be no IHT to pay.
Dividing the estate
The position is complicated where children are part of the picture. Where a married couple have children together, the value of the estate that passes to the spouse or civil partner and to the children depends on the value of the deceased’s estate.
The rules provide that the first £270,000 of the estate passes to the spouse, as do the deceased’s personal possessions – such as paintings or jewellery. The balance of the estate, including the deceased’s share of a property, is divided as to 50 per cent to the spouse and the remaining 50 per cent divided equally between the couple’s children.
There are two consequences to this division of assets that could prove problematic.
Once an individual reaches 18 they are absolutely entitled to their inheritance and can dispose of this as they please.
The first, and more obvious, is that it may not be prudent for children to inherit a potentially sizeable amount of money, or a share in a valuable asset.
Many testators stipulate in their will that their children should inherit funds having reached an age that they consider appropriate. The intestacy rules state that once an individual reaches 18 they are absolutely entitled to their inheritance and can dispose of this as they please.
For an example of the above, let's consider a married individual with children who had no will and held a half share in a property worth £2.5mn as tenants in common, as well as a portfolio of shares in their own name worth £500,000.
The amount passing under the intestacy rules would be £1.75mn, being a half share in the property and the total value of the portfolio. In these circumstances the surviving spouse would inherit assets worth £1.01mn with the remaining £740,000 being divided between the couple’s children.
Stepchildren are not recognised under the intestacy rules, even if the deceased treated their stepchildren as their own.
The children would be under no obligation to transfer their share of the estate to their surviving parent, even if they were over 18 and could do so.
The second adverse consequence of this scenario would be that the assets passing to the children would be chargeable to IHT.
Provided the deceased had not made any significant gifts in the seven years before they died, and the residence nil-rate band applies to the estate, the IHT liability payable would be around £96,000 – a bill that could otherwise have been avoided.
The estate of the second spouse to die would also not benefit from the tax-free allowances passing to their estate in due course.
An uncommon but by no means implausible example of it being undesirable for children to inherit their parents’ assets would be if the deceased were to have owned business assets.
Where the business’ articles of association allow shares to pass to the beneficiaries of one’s estate, these would form part of the assets divided between the surviving spouse or civil partner and the children.
The rules also do not recognise separation, as opposed to divorce.
This could leave some of the shares in the hands of the deceased’s children, which may not be in the best interest of the business and not what the deceased business owner would have wanted.
Stepchildren are not recognised under the intestacy rules. This means that if the deceased married someone with children from a previous relationship, even if the deceased treated their stepchildren as their own, the stepchildren would not inherit anything if the deceased did not have a will in place that provided for them.
Rules on marriage
The rules also do not recognise separation, as opposed to divorce. This means that if a married couple become estranged and one dies without a will the spouse would retain the right to inherit £270,000, the personal possessions and half of the remaining assets under the rules.
A married couple or a couple in a civil partnership who are in the process of divorcing or ending the civil partnership should consider completing a new will if they would not want their assets to pass to their spouse or partner.
While divorce does not revoke a will, marriage on the other hand does. This means that if there is no reference in a will to a person’s intended marriage or civil partnership, the will becomes invalid once the marriage or civil partnership takes place.
The child making the variation must not receive any incentive or compensation for completing the variation.
While the terms of the revoked will may be taken into account in any claim made against the estate, the intestacy rules would apply to the estate in the first instance, leaving any disappointed beneficiary to consider whether to make such a claim.
The adverse consequences of the application of the intestacy rules can be overcome if the recipient of assets chooses to vary their inheritance. To do so the beneficiary must be over the age of 18 and have the requisite mental capacity to do so.
Provided it takes place within two years of death, the variation can be treated for IHT purposes as if the ultimate beneficiary of the assets had received it under the intestacy rules.
For example, where adult children inherit their parent’s assets under the rules and complete a deed of variation within two years that passes these assets to their surviving parent, HMRC will apply the spousal exemption to the assets and consequently reduce any IHT liability.
The child making the variation must not receive any incentive or compensation for completing the variation. The variation will also be treated as a gift made by the child for the purposes of any examination of their care needs.
The division of assets between various family members can cause disharmony at a precarious moment.
While sometimes rectifiable, the pitfalls of the application of the intestacy rules are numerous and potentially costly. As seen above, the only circumstances in which they are likely to coincide with the wishes of the deceased are where the deceased was married and did not have any children or other dependants.
In other scenarios, the division of assets between various family members can cause disharmony at a precarious moment.
Family members seeking to administer the estate would need to make an application to the court that would assess their competing claims to do so. Whoever is successful in being appointed the administrator of the estate would be charged with paying any IHT due and adhering strictly to the intestacy rules.
The numerous challenges and unintended outcomes outlined above can be avoided if an individual takes the opportunity afforded to him or her to pass their assets as they wish by completing a will.
Richard Burgess is a senior solicitor at Moore Kingston Smith