Nature of annual sum received by life tenant

Dear Fellow TDF members,

I would be grateful for readers’ views on the following clause in a Will:

“MY TRUSTEES shall stand possessed of my Residuary Estate UPON TRUST to pay its income for MISS X for her life and I DIRECT that my trustees shall give to the said MISS X a monthly payment as after deduction of income tax at the basic rate for the time being in force will amount to the clear sum of ONE THOUSAND FIVE HUNDRED POUNDS (£1,500) and or such other clear sum as may be substituted therefor as hereinafter provided and the amount thereof shall be increased by five percent (5%) per annum from the date of the signing of the Will hereof and subject to this to the RESIDUARY CHARITY BENEFICIARY.”

should this payment be treated as an annuity even though the amount paid each year will increase?

In addition, there is insufficient income generated by the trust investments to cover the annual payments due to the life tenant so the shortfall is met from capital of the trust. Should the full amount received by the life tenant each year be treated as income received net of tax even though part is received from capital?

I would be grateful for readers’ thoughts on the above.

Kind regards,

These two provisions do not seem to be alternatives but cumulative. She is entitled to the income but it may be that it can be minimised without breach of trust by “absolute owner” and “no obligation to balance” investment powers (like STEP Special Provision 19). The annuity thus has to be paid out of capital. A spectacular own goal of the Seamus Coleman order of magnitude. I suggest you ascertain the drafter’s address for service. More constructively perhaps seek a compromise whereby Miss X settles for a lump sum without similar income tax consequences not to mention having to set aside a sum to invest to answer the annuity, thus delaying and complicating the administration. How expensive that would be will depend on her life expectancy and state of health. (I hope she is not resident in Scotland and I can safely say “her”).

Jack Harper

Dear Jack,

thank you for reply. There is no “absolute owner” as the only beneficiaries per the Will are Miss X during her lifetime and then any residue remaining is paid to a National Charity. The Trustees have invested the estate proceeds within investment managers and they are investing in a mixture of bonds and stock market shares. They pay out the monthly amount to the life tenant.

My question was more around whether the monthly payment is an annuity or if the fact that it increases by 5% each year means that it cannot be an annuity.

I want to know this because the tax payable will be much higher if the £1,500 (as increased by 5% each year) amount needs to be treated as an annual payment under ITA 2007 s963.

My reference to “absolute owner” was to a possible trustees’ powers of investment such as per James Kessler:
“The Trustees may make any kind of investment that they could make if they were absolutely entitled to the Trust Fund.” But it seems likely that the testator wished to provide for Miss X for life and for the charity just to have anything that was left. Tax efficiency may not have been paramount.

The amounts payable are clearly taxable to the recipient under s683 ITTOIA 2005 and after deduction by the PRs under s901ITA 2007, assessable on them under s963: TSEM3784. Section 901(2)(b) does not exempt as the deceased was not liable to pay. PRs need to fill in the Boxes at Q11 on the SA900.The reason this is “comparatively rare” is that there are usually better ways of structuring a gift of income. The 5% p.a increase does not change the nature of the receipt as an annual payment. Regrettably directing by Will that an annuity be purchased is a long-standing and notorious elephant trap and should have been drawn to the testator’s attention so that, duly informed, he could have instructed it to be included even so if he wished: Hurlingham Estates v Wilde [1997] STC 627.

A purchased life annuity would be ideal but the rules do not apply to one purchased by PRs. A single premium insurance bond could help to fund the annuity, postponing the tax on the profit for 20 years.

It seems that Saunders v Vautier could well apply and that the charity might be glad to share the capital otherwise needed to fund the annuity with Miss X on an agreed basis. The PRs may feel that this was not what the the testator had in mind at all but they cannot stop S v V applying if it does on the facts.

Jack Harper