Gift from a Discretionary Trust?

[sageorguk]

When my Mother died 5 years ago, her assets were placed in a nil-rate discretionary trust. My stepfather has a life interest in the trust, my siblings and I are the ultimate beneficiaries on his death. One of my Mother's assets was a 1/3rd share in the property her mother lived in, her mother having gifted this to my mother and her siblings some years before. Last year my Grandmother died and the property was sold, my Mother's trustees receiving the proceeds (approx £56k).

My stepfather has decided that he would like this money to come straight to my siblings and me, rather than remain in the trust. His solicitor has said that, if my stepfather were to die in the next 7 years, this would affect his IHT position and potentially result in a higher IHT bill. As a result my siblings and I have been asked to sign an indemnity to say we would cover the additional IHT costs should this happen.

Is this correct? The solicitor is calling this a "gift" from my stepfather. But this was my Mother's asset which formed part of her trust, so it has never belonged to my stepfather - unless there is something in the meaning of a "life interest in the trust". My understanding is that, on his death, the assets in the trust pass to my siblings and me and don't become part of his estate. So how can anything in the trust affect his IHT position? Am I missing something?

I would ask his solicitor (the trustee), but he has failed to answer other questions I have asked and made a lot of errors, so I would like to get another view.

Thank you

Steve G

[pqtaxation]

You write your Mum died five years ago and her will created what you call a “nil rate discretionary trust”. It is not clear to me what you mean. Taxation of trusts changed on 22 March 2006 so the terminology applicable is dependent on which side of that date in 2006 your Mum died. Assuming it was after 22 March 2006 it looks like, from what you write, that your Mum’s will created an immediate post death interest (IPDI) trust from which your stepfather during his lifetime is paid all the interest earned (if any) and on his death the capital goes to you and your siblings (the remaindermen). It looks likely that her will bequeathed to you and your siblings assets to the value of her nil rate band and the residual balance to the IPDI trust to benefit from the spouse exemption.

From what you write the solicitor trustee looks to be quite correct: i.e. the ending of your stepfather’s life interest in the proceeds from the sale of 1/3 share of your grandmother’s house is a PET by your stepfather. Thus if there is a liability to IHT on his PET arising from his death within 7 years then that liability is payable by you and your siblings rather than from his death estate. The IHT liability on the aggregated death estate and trust is apportioned pro-rata between them.

From what you write you are confused about the different types of trusts and their taxation which is unfortunate but very understandable owing to the strange legal terminology of trusts and their taxation. To make matters worse you write you that you have little faith in the solicitor even though he presumably was your mother’s solicitor as he is a trustee of her will trust. Presumably there is a good relationship with your stepfather as he is willing to advance you the proceeds of the house sale. Maybe you could get his agreement to your seeing the solicitor (at your cost) for a face to face question and answer session so that you gain a better understanding.

[pqtaxation]

From re-reading your original post, you did write that your mother's death estate passed to the (IPDI?) trust (with you and your siblings as remaindermen/capital beneficiaries) and I was mistaken in writing at end of my first paragraph that it looks likely that a legacy was left to you and your siblings under her will.

This mistake on reading your post does not however cause me to seek to change any of my other comments/views on the situation you describe.

[maths]

His solicitor has said that, if my stepfather were to die in the next 7 years, this would affect his IHT position and potentially result in a higher IHT bill.

This is possibly correct; depends upon the numbers.

Your step-father appears to have a "qualifying interest in possession"; this means he is entitled to the income of the trust. However, for IHT, it also means he is deemed to also own the trust property (which of course in reality he does not).

Thus, were he to for example surrender his interest he is deemed to have made a gift (ie a PET) of the trust property. If he survives 7 years no IHT and no problems.

If he dies within 7 years then the amount of the gift is taken into account in working out his nil rate band at the date of his death. Because of the gift his nil rate band (normally £325K) will be reduced thus increasing the IHT payable on his estate (ie the assets he owns at death). If he had not made the PET then he would have had a greater amount of nil rate band on his death and a lower IHT charge at that time.

Assume at his death his estate is 400K. IHT 40% x [400k - 325k] ie 30K.

However, if he died within 7 years of PET (of say 100K) then IHT would be:

40% x [400K - [325K - 100K]] ie 70K.

Also you are liable for any IHT which may arise on the PET itself.

This, as you say, is not in "real life" a gift from s-father but for IHT it is effectively treated as such.

What he seems to be saying is that you do not inherit until his death; however he's happy for you to inherit now but only if you indemnify him re extra IHT he may have to pay on death.

Theoretically, your exposure is up to a maximum of 40% of 325K ie 130k.