Lewis insists it is important in these calculations to be pessimistic and plan for the worst case scenario – at least that way there are no unpleasant surprises.
Consider a retired couple who want to review their Estate planning and look at opportunities for inheritance tax mitigation.
The couple have two grown up daughters, with the youngest suffering from a long term depressive disorder. Her condition means that she is not sufficiently responsible to be given unfettered access to a large amount of money.
The elder daughter is married and has young children. The younger daughter is divorced but also has young children.
Wealth passed down
The couple want their wealth to pass in equal shares to their two daughters following their death. They also wanted their grandchildren to eventually derive some financial benefit. However, they are worried about how the younger daughter would cope with an inheritance that would comfortably exceed £1 million (given the rise in property prices in recent years, there are ever-increasing numbers of estates in this bracket). They had previously executed Wills that they thought would provide a solution to this predicament. Their wealth would be left solely to their elder daughter (she had not been told of this) who would be trusted to pass money on to her sister and children as required.
"Firstly, even the best family relationships can come under pressure. In this instance, the elder sister could be required to supervise her sister's 'inheritance' for 40 years and a lot can happen in a relationship over that timeframe.
"More significantly, the younger daughter's notional inheritance would be an asset of the elder daughter. How would the elder daughter feel if her relationship with her husband broke down, they split, and he walked away with a 50% share of her sister's £1m inheritance? She may feel she had let down not only her sister and her children but the expressed wishes of her parents. "
What if the elder daughter was sued as result of an uninsured accident or other event? All of the money could have been taken from her.
Worst case scenario
What if the elder daughter died? Assuming 'personal' assets alone utilised the Inheritance Tax (IHT) nil rate band, 40% of her sister's inheritance could have disappeared in death duties. Bearing in mind that IHT would also have been paid on her parents' Estate, the effective marginal tax rate on capital finally passed to the younger sister would be 64%.
Not surprisingly, the parents in this instance would be shocked when the possible implications of the existing Will were explained to them.
Neil Mumford, chartered financial planner with Milestone Wealth Management agrees that dialogue explaining to the parents the implications of their supposed water-tight (but anything but) Will, and possible IHT implications would need to be conducted as a matter of urgency.
The first job would be to consider the alternative options and then refer the matter to a specialist solicitor to stress test the strategy and draft the appropriate documents.
In this instance the Wills would be subsequently changed so that the younger daughter's share of the inheritance would pass to a discretionary trust and a letter of wishes would guide the trustees.
Lewis elaborates: "The elder daughter would be nominated as a trustee of the new arrangement. She would therefore participate in looking after the financial needs of her sister as first intended. However, because a trust is a separate legal entity, there could be no call upon it from her future creditors and the money would not be subject to IHT twice whilst passing from parents to daughter.
Doing the sums
In terms of the couple reducing their IHT liability, the first step would be an assessment whether it was feasible that some capital be gifted directly or passed to trust now.
Since both parents are in their eighties, it would be important to establish what money they might need in the future. The costs for the best care homes in their locality have to be calculated and then compared to the income flow from occupational and State pensions.
"The difference between cumulative net pension income and cumulative care costs identified the funding gap, and a discounted Cashflow calculation using a modest return assumption was used to calculate the capital that should be retained.
"The balance of capital is therefore available to gift and a decision can be made to immediately create a series (more tax efficient for larger amounts) of trusts funded separately by each parent. They are able to each gift an amount equivalent to the IHT nil rate band and hope to survive 7 years so that the gift becomes exempt.
"The trusts are intended to provide sustenance for both children and grandchildren so a long term investment strategy has been adopted. The potential IHT savings would prove significant."
After all, why give money unnecessarily to the taxman.