Trusts for Wills

When you write your will you will not always know exactly what to give to whom. This is because the value of your estate is likely to have changed from to the time when the will is signed to the time of your death. In addition, the financial needs of your loved ones might vary. If you do not want to specify an exact amount to give a beneficiary in your will a trust might be the answer. Your chosen trustees (often also the executors, but not necessarily) will look after the running of the trust after your death and they can be given wide discretion as to how much and to whom any trust assets should be left. Essentially, you place the assets into trust and give discretion to the trustees.

Generally, trusts allow for:

  • Flexibility
  • Benefitting people in a way that may not be clear when the will is drafted
  • Leaving life interests
  • Restricting the passing down of assets in some way
  • Changes arising from new situations

Discretionary Trusts

A discretionary trust can be used for many different scenarios in conjunction with the points raised above. You can give or restrict the powers you give your trustees to realise your intentions.

An example of this might be that you may wish to benefit your children or grandchildren, but not know whether you might have more after your will is finalised. A trust would allow the trustees to benefit future children or grandchildren, and sometimes even those born after your death.

Trusts can be used to restrict income or gifts to beneficiaries. If you do not wish to leave a proportion of your estate outright to a specific person, a trust allows the trustees to pass smaller sums over a period of time. This can be useful if you are worried that the beneficiary will spend their inheritance too quickly, or you are worried about, for example, your child’s spouse benefitting if there are marital problems.

There are of course a huge number of scenarios where a discretionary trust is advisable, and if you think your circumstances merit one, you should seek further professional advice.

Life interest trusts

A common reason for a life interest will trust is to leave a right for someone to live in a property for the rest of his or her life. For example, if you cohabit with someone and have children from a previous relationship, you might leave the right for the person with whom you now live to reside in your property for the rest of his or her life, then pass the capital to your own children. Thus there are two classes of the beneficiary: the person who enjoys the gift for their life (the ‘life tenant’) and the eventual beneficiary (the ‘remainderman’).

Life interest trusts do not necessarily have to consist of real property. For instance, you might leave the income of an investment to the life tenant and the capital (on their death or other chosen cut-off point) to the remainderman.

There can be tax advantages (and disadvantages!) of doing this which are discussed below.

Other reasons for will trusts

Will trusts are flexible and varied, and there are a multitude of reasons for choosing them.

In some settlement trusts, there are special Inheritance Tax (IHT) benefits:

  • For immediate post death interest on life interest trusts.
  • For the disabled.
  • For bereaved minors.
  • For bereaved young people.

Immediate post death interest

This is where there is a life interest trust in place. An immediate post death interest is where someone is beneficially entitled to an interest in possession. An example would be if the property is left to a wife for life with the remainder to a child.

Disabled

Where the beneficiary is disabled there are no anniversary or exit charges on the Trust.  That is to say there is no charge on the 10th anniversary or when the settlement has ended and the assets paid over to the beneficiary.

Bereaved Minor

In the case of bereaved minors there are special rules. Certain conditions apply:-

  • Created by a will or intestacy for the deceased’s own child.
  • The minor becomes entitled to the property and any accumulated income at 18 years of age. If under 18, any capital must be applied for their benefit as well as any income.

If the conditions are met, there is no charge to IHT on the 10th anniversary nor on the transfer of the property to the beneficiary or the ‘exit’.

Bereaved young people

Another special provision is for bereaved young people.

The conditions for the special provisions to apply are as follows:

  • The trust must be for the deceased’s own child.
  • The child must become entitled to the settled property at or before the age of 25.
  • Up to the age of 25 any capital must be applied for the benefit of the child and then it should also have the benefit of any income arising.

The inheritance tax treatment for a trust for bereaved young people is that there is no anniversary charge after 10 years, but there will be an exit charge based on the amount of time the property has remained settled since the beneficiaries 18th birthday.

Broadly, the approach is:

  • Value at the time set up and increasing value since the trust’s creation.
  • A 20% charge is applied (the lower IHT or half the death rate of IHT). If the value still remains within the nil rate band there is no charge.
  • From this apply a settlement rate using a table of rates: tax will then be 1/40th for each quarter from the age of 18 to the date of exit.

Note that, if the trustee decides to use their discretion to set up a further trust before the young person has reached the age between 21 and 25 specified in the trust, they could do so.  This might arise if there are concerns about the maturity of responsibility of the beneficiary.  However, the result in this case would be that an exit charge for IHT purposes would apply at that time.

A ’precatory trust’

This is where the deceased gives objects to a beneficiary on the basis of an expression of wish for example, for the beneficiary to hold on trust for the benefit of someone else. As a matter of fact this is not a proper trust because a trust has to have certainty whereas in this case the executor of the Will has a broad discretion.

For example:

’I express the wish (without imposing any legal obligations) that the trustee should distribute such assets in accordance with any instructions I communicate to him orally or in writing at any time’.

In such a case, inheritance tax would be payable if no exemption applies. For example, if the gift is not to the spouse but someone else there would be an inheritance tax charge subject to the normal rules of calculation.

Different rules will apply if the gift is not payable in 2 years.

When a gift is made under a precatory trust, capital gains tax will be payable but only if there is a gain. However, note that there is attachable moveable property exemption applicable to certain assets with a consideration of £6,000 or less. Also annual exemptions will apply.

Flexible trusts and their tax implications

As discussed above, we can advise you on the circumstances where trustees will have flexibility to adapt according to the circumstances prevailing after your death.

There are two approaches to a flexible will:-

  • The property is left to the executors and trustees on discretionary trust. These trusts will have wide powers in terms of what the trustee can do with the capital and income and gift to the beneficiaries.  If the powers of appointment are not exercised then they will pass to the beneficiaries.
  • The property can be left to an individual for life but with powers of appointment. An example could be to provide property to the spouse for life to be given to the children but with power attained by the trustees to appoint trust property to the discretionary beneficiaries or indeed to terminate the life interest of the spouse.

This discretion means that in the event, for example, that the spouse is comfortably off, there is flexibility to benefit the children.  Alternatively, flexibility could be given to provide to the spouse if she had significant financial needs.

From an inheritance tax (IHT) point of view the second approach (to the spouse for life with powers to appoint property to the children) has the advantage that there is no inheritance tax payable because of spouse exemption.  The inheritance tax implication of the interest then being passed over to the other beneficiaries would be that there is a Potentially Exempt Transfer (PET).  If the spouse then lives for 7 years then there is no inheritance tax payable!

A flexible will

Sometimes the approach will be to give a settled legacy to be held on flexible trust.  The remainder will then be passed to other beneficiaries to receive absolutely: that is to say they will receive the benefit immediately rather than via the intermediary of the trust.

A trust can be made out to last for up to 125 years although the reality is that the benefits will be paid out well before this provided there are the appropriate powers of appointment.

One thing to consider is whether to keep the value of the settled legacy to the maximum of the available nil rate band.  The advantage of this is it will prevent inheritance tax from being payable when discretionary powers are exercised.

Inheritance tax and flexible trusts set up by a will

Distributions within 2 years

There is a special rule allowing for distribution without additional inheritance tax (IHT) implications of property from a settlement within 2 years of the death. Otherwise there is a periodic charge and exit charge where the property is distributed.

Nil rate band discretionary settlement

These are rarer now because of transferable nil rate bands: if one spouse dies any nil rate band not used can be applied to the estate of the surviving spouse.

As a result nil rate band discretionary trusts are less common but there are potential advantages for such as

  • where assets which may increase far sooner than the value of the nil rate band so that tax can be saved on any increase;
  • funds can be made available to the beneficiaries if they need them;
  • capital is protected if the surviving spouse remarries;
  • savings can be made on means tested residential care fees.

A problem can arise however where a valuable property is owned. The concern for the surviving spouse might be there are other assets other than the home to make up to the level of nil rate band. One approach is to offer the trustees a debt instead of the actual property. These can be typically secured on assets in the possession of a surviving spouse.

Part of arrangement the benefits are:-

  • The first spouse who makes full use of the nil rate band. Then going to the surviving spouse.
  • The surviving spouse can use all the assets without having to pay inheritance tax.
  • When the surviving spouse dies assets will be reduced in value for inheritance tax purposes.

Capital Gains Tax (CGT) and flexible trusts

If the intention is to pass the assets to the beneficiaries without delay it is a good idea to do this without the property being passed to the trustees as it will avoid CGT arising.

In other cases where there has been a rise in value before the assets are transferred to the beneficiary CGT liability will arise. Hold over relief may be available meaning that the Trustees will not pay capital gains tax when the assets are transferred but it would be payable when the assets are sold by the beneficiary. It should be noted that the hold over relief is not available within the first 2 years of death.

Income Tax implications of discretion with trusts in wills

It should be noted that where a beneficiary does not have a right to income from the flexible trust it will be taxable. Over £1,000 the dividend trust rate or the trust rate will apply.

Wills incorporating a terminable life interest

It is common for people to leave in their will provision for their surviving spouse combined with flexibility so that other members of the family can benefit.  It may transpire that one of the children has a greater need. We can help you achieve this with a will in which the surviving spouse has a direct benefit by obtaining a life interest but the trustees are then allowed to give property to those other than the spouse, particularly the children.

In this arrangement the IHT benefits are:-

  • the spouse with the life interest will have the spouse exemption
  • the proportion of the nil rate band not used on the first spouse’s death can be transferred to the surviving spouse
  • for deaths after the 6th April 2017 the first spouse’s additional residential nil rate band can also be transferred. This allows for any of the descendants to benefit.

Possible claim by a surviving spouse or civil partner

Contrary to what you might think there is a limit under the Inheritance Act to your freedom to leave your property to whoever you choose. There is statutory protection for surviving spouses or civil partners.

This could mean that the starting point, as in family law, for assessing the division of property would be 50/50.