Tax or no tax - second spouses and children

It is not unusual for there to be disagreements when an estate is divided up after a death, when emotions are running high.  A well-drafted Will can help to avoid some of the difficulties that can arise, however, there is one particular difficulty which can arise where an estate is divided between beneficiaries who are liable for Inheritance Tax (such as children) and beneficiaries who are not liable to tax, such as a spouse. 

Often, where there is a second marriage, the residue of an estate will be divided between the children of the first marriage and the second spouse.  The difficulty here is Section 41 of the Inheritance Tax Act 1984 which, rather unhelpfully, states that none of the Inheritance Tax is to fall on the spouses's share. Whilst this seems to be simple common sense, it produces a rather odd result, particularly if the Will is unclear.

Let’s take an example. Suppose Jim leaves an estate of £1,000,000.  He has one nil rate band of £325,000. He was married to Sarah and together they had two children. They divorced and Jim married Tracey. They did not have any children, preferring instead to spend their time travelling the world and enjoying themselves.  Jim is now on his death bed and feels rather guilty about the money he and Tracey have spent.  He decides to leave Tracey (who, as his spouse, is an exempt beneficiary) just 10% of the estate, with 90% is to pass to his children.  Although he may not realise it, Jim has a choice about how the figures are to be calculated.

The first approach (known as the re Ratcliffe approach) would be for the Inheritance Tax to be deducted from the 90% passing to the children and Tracey would receive 10% free of Inheritance Tax. 

The alternative approach (known as the re Benham approach) is to treat the children as entitled to a larger share of the residue so that after Inheritance Tax is paid, they end up with the same amount per share as Tracey receives per share. With this approach, the children end up with a little more and Tracey ends up with a little less.  In addition, the estate has to pay additional Inheritance Tax.

If we use figures to illustrate how this works, the results would be as follows:

  • Under the re Ratcliffe approach, the children would receive £670,000 whilst Tracey would receive £100,000.  The Inheritance Tax would be  £230,000. 
  • Under the re Benham approach, the children would receive approximately £684,375 and Tracey would receive approximately £76,041. The Inheritance Tax would be approximately £239,583.        

The re Ratcliffe approach is the one which the Courts tend to favour but sometimes, and for very good reason, the re Benham approach is the one that the client actually intended. This is an area of law which is often misunderstood and it is very important to make sure that you discuss with your advisor which approach you want to use. A clause can then be included in the Will to make this crystal clear, which will help to reduce uncertainty and, inevitably, the additional cost that goes with it.

For advice or more information, contact Ros 0swald.

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