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Anthony Nixon looks at the Use of Trusts in Wills, in response to a recent TaxationWeb Forum query. 

Introduction - Question from TaxationWeb's Forum

A recent TaxationWeb Forum query asked the following:

“My will leaves the single Inheritance Tax Band (Nil Rate Band - NRB) to our children on my death with the balance of my estate going to my wife. My wife has an identical will. We can both afford to do this as each of us would still be adequately provided for - our house is owned by my wife and me jointly. Is there any advantage in setting up a discretionary trust?”

Reply - The Benefits of Trusts

If you feel that the survivor of you can afford the first to die giving away the NRB, there is almost certainly more you could do with your wills to plan for IHT and to protect your children.

I think that the most serious problem with your wills as they stand is their inflexibility.

The conservatives have promised a £1Million NRB. Whether or not this particular promise is kept, there is always the risk that, at the time of the first death, the NRB will be a much larger amount in relation to your joint assets, so that, unlike the position today, the survivor cannot afford to do without all of it.

Since the 2007 introduction of the transferable NRB, conventional wisdom has moved to the view that it is not worth making special provision for the NRB on the first death at all. If the first to die leaves everything to the surviving spouse, and has made no other use of the NRB (for example, gifts to taxable beneficiaries in the will, lifetime gifts within seven years of death, interests in trusts taxable on death) then the survivor has a double NRB available.

Nil Rate Band Trusts

But wills with NRB trusts on the first death can still be very useful.

In contrast to your present wills, the survivor of you, as well as the children, is a potential beneficiary of the amount of NRB. If the NRB has increased disproportionately, benefits can be kept for the survivor.

If either spouse owns assets which can obtain Business Property Relief or Agricultural Property Relief, a similar trust can capture relief on the first death, even if relief is no longer available when the second dies.

If an individual has been widowed more than once, the NRB trust is still essential to get the maximum benefits.

Splitting ownership of a home or of a family business that does not qualify in full for Business Property Relief can bring extra IHT savings. Consider the following example.

Example

Suppose Jonathan and Janet Freeman owned Comfy Cottage, currently worth £760,000, and that Jonathan has recently died. Let us also suppose that, when Janet dies, in several years' time, the value of Comfy Cottage has increased by 30% to £988,000 and that the NRB has also increased by 30% to £420,000.

If all of Jonathan's half share goes to Janet now, the NRB on Janet's death is doubled and £840,000 of the house's value is free of IHT. 40% IHT on the balance of £148,000 is £59,200.

But if Jonathan's half of Comfy Cottage goes to an NRB trust, the taxable value of the house is reduced by splitting it into two halves.

Because Janet still has the right to live in the house, thanks to her half share, HMRC would accept the value of Jonathan's half at a 15% discount. Instead of £380,000 (half of £760,000) it would currently be worth £323,000 (half of £760,000 less 15%). This is below the £325,000 threshold which applied at Jonathan's death, so that the whole of his half of the house could go to the trust and be outside Janet's estate on her death.

After Janet's death her half of the house (then worth £988,000 as a whole) is worth no more than £444,600 (half of £988,000 less 10%). Only £24,600 is over the then £420,000 nil rate band available to her estate and IHT at 40% on that £24,600 is £9,840.

The IHT saving is £49,360 on these figures.

Whatever figures one uses, if the value of the house and the amount of the IHT threshold increase in line with one another, splitting ownership of a valuable house takes 12.5% of the value of the house, at the time of Janet's death, out of IHT.

If the value of the house rises faster (perhaps because of development value) the saving is even greater. Only if the IHT threshold rises faster, will there be a disadvantage, and only then, when the 12.5% advantage is eroded.

Exactly the same applies to shares in family companies, if 100% Business Property Relief is unavailable or is restricted.

Example

Suppose Jonathan and Janet each owned 30% of the shares in Freeman Properties Ltd, a company without relief. If all the shares go to Janet now, a 60% holding will suffer IHT when she dies. The discount to asset value is unlikely to be more than 10%. But if enough of Jonathan's shares go to an NRB trust to take Janet's total below 50%, the discount on Janet's shares may increase to, say, 40% and the discount available when calculating the number of shares that can go to Jonathan's trust may be even greater.

Wills and Future Generations

Finally, I believe there is now more and more value in making gifts in wills to the next generation through trusts.

a) If young children are beneficiaries, the IHT rules are of bewildering complexity. The particular rules that take effect may be dictated by nothing other than the age of the children on the testator's death. It is impossible to know this when the Will is made.

'Trusts for bereaved minors', 'age 18-25 trusts' and 'immediate post-death interest' trusts may all have their place, but there is little point in making a choice at the time the Will is drafted.

IHTA s 144 allows trustees to convert a wide discretionary trust set up in the Will to any of these other forms of trust, if that is what is required. Alternatively, provided the trustees wait more than three months after the date of death, the gift within the discretionary trust can be converted to an absolute gift to, or a bare trust for, the children.

b) If young or improvident adults are beneficiaries, a trust can protect funds from being squandered at too early an age. A trust may also protect the beneficiary against business mistakes or matrimonial disasters. If the beneficiary is bankrupt at the time of the testator's death (or is made bankrupt soon after) an outright gift automatically goes to his creditors.

c) If there are adult beneficiaries with young children of their own, particularly if they are paying school fees for their children, it is a positive advantage for inheritances to come to them in the form of a trust. The trust can be organised so that, for the time being, any income belongs to the young children, who will usually have personal allowances and lower rate bands of tax available. Compare this with the beneficiary paying the school fees from his own pocket after 40% (or, from next year, 50%) tax.

d) Older beneficiaries may already have IHT problems of their own. If they receive gifts within a trust, they can still benefit, to whatever extent they wish, but the inheritance does not add to their own estate. There is a risk of ten-yearly 6% IHT charges but this will be much cheaper than 40% IHT on death.

e) Handicapped, disabled or elderly beneficiaries may be unable to manage assets and may be able to preserve their rights to means-tested benefits and allowances.

In every case the trust in the Will is only a starting point. IHTA s 144 allows almost any variation to be made in the two years after death, without adverse tax consequences.

It is essential, of course, to appoint trustees who can be relied on to take the right decisions after the testator has died. But, provided clear guidelines are given, the best decision can be taken according to the circumstances (and the tax rules) that exist after death.