How to draft Wills to mitigate IHT for residuary legatees where cohabitees leaving life interest trusts in favour of each other

Trusts Discussion
1

I am a Wills and Probate solicitor and I wondered if anyone could help me with the following problem.

We have received instructions from a married couple, X ,the male, and Y, the female. X owns a country cottage lets say worth about £600K which they both reside in and Y owns another property which is rented out worth about £350K and from which she receives income. X has five children from a previous marriage and Y has two children. (Both X and Y have other cash asset worth about £100K which they also intende to pass to their respective children from previous marriages.)

X wants to leave a legacy of his cash assets to his children and his cottage to his five children in his Will subject to a life interest in the cottage in favour of Y.

Y wants to leave her cash assets to her children and her property to her two children subject to allowing X to receive the income from her property rented out for the rest of his life making him a life tenant of it.

If the Wills are prepared in this way and the IHT implications considered it would appear that a somewhat unfair situation arises in the two possible scenarios that follow:-

  1. If X dies first, the cottage will be placed in a life interest trust for the rest of Y’s life. On her death the cottage will pass to X’s five children who will not bear any tax on it but as I understand it the full value of it will be added to Y’s estate for IHT purposes as she is the life tenant and, after taking off any nil rate band and transferable nil rate band, it will be Y’s children, as residuary legatees, who pay the IHT arising from the life tenancy before they inherit the residue of the estate.

  2. If Y dies first, her house will continue to bear income for X during his lifetime. When X dies the house passes to Y’s children who do not bear any tax on it but the full value of her house is added to X’s estate for IHT purposes as he is the life tenant and after taking off any nil rate band and transferable nil rate band, it will be his children, as residuary legatees, who pay the IHT arising from the life interest before they inherit the residue of the estate.

I was just wondering whether anyone has come across this problem before and whether they have any suggestions as to how the Will might be drafted so as to avoid this unsatisfactory situation arising.

Julia Jamieson
Pellmans LLP

2

Although it is correct that when a life tenant dies in these circumstances the trust property is aggregated with his or her own estate for the purpose of working out the total IHT bill, that IHT liability is then split between the free estate and the trust property. The tax on the trust property is then charged on the trust property, so there is no unfairness. The tax on only the balance is payable by the residue of the estate.

Julian Cohen