Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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March 2005

Q:

Could you tell me please if a Discretionary Will Trust only applies to married couples? We are an unmarried (or common law) couple who wish to use a Discretionary Will Trust if possible but cannot see where this is defined.

A:

A Discretionary Will Trust is broadly a trust written into a Will, with trustees (who are normally the deceased's personal representatives) and beneficiaries who usually include the surviving spouse (if there is one), family members, close friends, etc. With increasing property prices in particular resulting in more people having to consider inheritance tax (IHT) for the first time, Discretionary Will Trusts are being used by many married couples to achieve potential IHT savings. The reason for this can be summarised as follows:

• Individuals domiciled in the UK are generally liable to IHT on worldwide assets (non-domiciled individuals are also liable, but on chargeable UK property). Their estates on death are subject to IHT at 40%, to the extent that their IHT allowance or ‘nil rate band' (£263,000 for 2004/05) is exceeded.
• There is an exemption from IHT for gifts or legacies between spouses domiciled in the UK. This means that if all estate assets of the first to die are left to the surviving spouse, there is no IHT liability. However, the surviving spouse's estate is correspondingly increased, and the nil rate band of the deceased spouse is effectively wasted.
• If a Discretionary Will Trust is set up it is possible, for example, for an amount up to the nil rate band to be left to the trustees, with selected potential beneficiaries (e.g. wife/husband, children and other family members). The trustees have discretion over how the trust capital and income is dealt with. However, it is quite common for an individual to write a ‘letter of wishes' at the same time as his/her Will, requesting that the trustees consider exercising their discretion in favour of a particular beneficiary, usually the surviving spouse.

The intended effect is generally that the trust fund is available to the surviving spouse if required (subject to the trustees' discretion), without enlarging his or her estate for IHT purposes. The available nil rate band of the first to die is also used. By applying the IHT nil rate band in this way, a significant tax saving can be achieved (up to £105,200 for 2004/05, i.e. the nil rate band of £263,000 multiplied by the 40% ‘death rate' of IHT).

There is nothing to stop an unmarried couple making Discretionary Will Trusts. In fact, they can be quite useful, e.g. if there is some uncertainty when making the Will over who should benefit from the estate on death. A transfer of trust capital to beneficiaries after three months but within two years following death is treated for IHT purposes as having been made by the Will, although there may be possible capital gains tax implications. However, under present law, the above IHT exemption for gifts and legacies between spouses requires the couple to be married (although as a result of the Civil Partnership Act, registered same-sex couples are soon to be treated the same as married couples, with the necessary legislation expected to be introduced in Finance Act 2005). This means that if you remain unmarried and leave assets to your partner in the Will there may be a liability to IHT on death, but only to the extent that the estate value exceeds your available nil rate band. On the first death, the nil rate band is potentially used by a legacy to the surviving partner and is not wasted due to the surviving spouse exemption, which is an IHT objective of Discretionary Will Trusts.

Mark McLaughlin

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