Lifetime gifts are often made with the intention of helping family members during the testator’s lifetime. However, they can create complications when preparing a will, particularly where the testator wishes beneficiaries to be treated fairly or equally overall. This is the second of a two-part series examining lifetime gifts as part of estate planning. This article focuses on lifetime gifts and will drafting.
Part One considered the IHT treatment of lifetime gifts, including PETs, CLTs, exemptions, taper relief, gifts with reservation of benefit and the effect of failed PETs on the NRB available to the death estate.
A will operates only on the property forming part of the estate at death. It does not automatically correct an imbalance created by gifts made during the testator’s lifetime. Unless the will provides otherwise, a beneficiary who has received a substantial lifetime gift may still receive their full entitlement under the will.
Lifetime Gifts and Will Drafting: Identifying the Testator’s Intention
Lifetime gifts should be considered whenever a will is prepared. A will should also be reviewed following substantial lifetime gifting or tax planning to ensure that it continues to reflect the testator’s wishes.
The testator should decide whether a lifetime gift is intended to be:
- an additional benefit that does not affect the recipient’s inheritance;
- an advance to be taken into account when dividing the estate;
- a replacement for all or part of a legacy under the will; or
- a loan that remains repayable.
Example
For example, a parent may intend that their children benefit equally overall but may already have given one child a substantial sum towards a house purchase. If the will simply divides the estate equally, that child may receive both the lifetime gift and an equal share of the estate. The result may not reflect the parent’s intended meaning of equality.
The will should therefore be drafted in a way that takes this into account and ensures equality. Situations such as this highlight why lifetime gifts and will drafting should be considered together rather than as separate issues.
Using a Hotchpot Clause
One of the main issues with lifetime gifts and will drafting is deciding whether earlier gifts should affect a beneficiary’s entitlement under the will.
Where a testator wishes to balance lifetime gifts between beneficiaries, the will may include a “hotchpot” clause. This brings specified gifts into account when calculating the beneficiaries’ shares of the estate.
Example
A parent gives Child A £100,000 and later leaves the residuary estate equally between Child A and Child B. At the parent’s death, the net residuary estate is £500,000.
A hotchpot provision could treat the amount available for comparison as £600,000:
- the £500,000 residuary estate; plus
- the £100,000 lifetime gift.
Each child’s intended overall benefit would be £300,000. Child A would receive £200,000 from the estate, having already received £100,000, while Child B would receive £300,000.
Matters to Address in a Hotchpot Clause
A hotchpot clause should clearly specify the following matters.
The gifts covered
The will may identify particular gifts or apply to gifts exceeding a stated value. It could cover all gifts, but that could make the personal representatives’ role difficult as every gift no matter how small would need to be considered.
The value attributed to each gift
The clause should state which value should be taken into account. This could be:
- the amount or market value when the gift was made; or
- an inflation-adjusted amount.
Using the original value may be simpler for the executors, but it may not produce economic equality where gifts were made at different times or comprised assets that have increased or decreased substantially in value.
The beneficiaries covered
The will should identify the beneficiaries to whom the provision applies. It might also make it clear that if a beneficiary predeceases, the adjustment should also apply to that beneficiary’s children.
Gifts made after the will
The testator may continue gifting after signing the will. The clause should state whether it applies only to gifts made before the will or also to subsequent gifts.
The Limitations of Hotchpot Provisions
Although hotchpot provisions can help equalise lifetime gifts, they are not particularly flexible. The executors must apply the formula set out in the will, even if circumstances have changed significantly by the date of death.
Difficulties may arise where:
- gifted assets have changed substantially in value;
- the death estate is smaller than expected;
- a beneficiary has died;
- beneficiaries’ needs or financial circumstances have changed;
- the tax position has altered; or
- strict mathematical equality would produce an inappropriate result.
For example, a parent may give Child A £100,000 towards a property purchase and include a hotchpot provision intended to equalise Child B’s inheritance. If the death estate later falls substantially in value, or Child B develops significantly greater financial needs, the fixed calculation may no longer produce the outcome the parent would have preferred.
Lifetime Gifts and Will Drafting: Using a Discretionary Trust
Where greater flexibility is required, a discretionary trust under the will may be considered. Instead of fixing each beneficiary’s entitlement, the will gives the trustees discretion to decide:
- which beneficiaries receive income or capital;
- how much each beneficiary receives; and
- when distributions are made.
The trustees can take account of circumstances at the date of death and during the administration of the trust, including:
- lifetime gifts already received;
- the value and liquidity of the remaining estate;
- beneficiaries’ financial needs and resources;
- IHT liabilities resulting from lifetime gifts;
- changes in family circumstances; and
- the testator’s intention to achieve overall fairness rather than strict mathematical equality.
A discretionary trust does not guarantee equality, but allows the trustees to respond to circumstances rather than apply a fixed formula. The selection of suitable trustees is therefore particularly important.
The Letter of Wishes
A discretionary trust should be supported by a non-binding letter of wishes. This can explain how the testator would like the trustees to approach lifetime gifts, tax liabilities and differences between beneficiaries.
A letter of wishes does not create legally enforceable entitlements and does not bind the trustees. The trustees must exercise their discretion independently.
The letter can generally be updated without executing a new will. This allows the testator to record subsequent gifts and changes in priorities more easily, although significant changes may still justify a review of the will.
Relevant-Property Charges and Section 144
A discretionary will trust will generally fall within the relevant-property regime. If the trust continues, it may therefore be subject to IHT charges on each ten-year anniversary and when property leaves the trust.
However, section 144 of the Inheritance Tax Act 1984 applies where the trustees make distribution within two years after the testator’s death. That distribution is treated for IHT purposes as if the interests created by it had been included in the will.
This treatment will prevent a relevant-property exit charge from applying within that two year period.
If the trust continues beyond the two-year period, or only part of the fund is appointed, the remaining property may continue within the relevant-property regime.
Allocating IHT
Ordinarily, the recipient of a failed PET is primarily responsible for the IHT attributable to that gift. The will may instead direct the estate to pay that tax, although doing so shifts the economic burden to the estate beneficiaries and leaves them with less from the estate. That may not be a concern however if the beneficiary in lifetime and beneficiary on death are the same people.
Lifetime Loans
Where a substantial lifetime payment is a loan, there are further considerations. The will could state the debt is to be:
- deducted from the borrower’s inheritance;
- released on death; or
- benefit of the outstanding debt be transferred to another beneficiary.
Releasing a debt on death may itself have IHT consequences. The release is generally treated as a transfer of value equal to the amount given up, subject to any applicable exemption or relief.
If the loan is not specifically dealt with, it would form part of the residuary estate and the benefit of the outstanding debt would pass to the residuary beneficiaries.
It is highly advisable for any loan to be evidenced by a written loan agreement or other written evidence. Reliance on an informal or verbal understanding can create uncertainty after the lender’s death and may lead to disputes between the borrower, personal representatives and beneficiaries. Without adequate evidence, the borrower may assert that the payment was a gift, while other beneficiaries may expect the personal representatives to recover it as a loan.
Keeping Records of Lifetime Gifts
Where a testator is making significant lifetime gifts, accurate records should be kept. This allows personal representatives to identify gifts, consider available exemptions and complete the estate’s IHT returns.
Records in particular would also assist in the operation of any hotchpot provision. It may also provide useful information to discretionary trustees considering how lifetime benefits should influence later appointments.
A gift schedule should not be used as an informal substitute for amending the will. If the testator’s intentions change materially, the will should be reviewed and updated.
Conclusion
Lifetime gifts and will drafting should be considered together. A substantial gift made during the testator’s lifetime may significantly affect the outcome achieved on death, particularly where the testator wishes beneficiaries to receive broadly equal benefits overall.
Hotchpot provisions can provide certainty, while discretionary trusts may offer greater flexibility where circumstances are likely to change. The most suitable approach will depend upon the testator’s intentions, family circumstances and the nature of the gifts that have been made.
Clear drafting, accurate records and regular reviews can help ensure that lifetime generosity does not unintentionally undermine the testator’s overall estate-planning objectives.
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This article is provided for general information only and does not constitute legal advice. Any advice, wording or clauses referred to are illustrative and should not be relied upon as precedent without full consideration of the client’s circumstances, the will as a whole, and the law in force at the relevant time.
