Malcolm Finney takes a look at a potentially useful inheritance tax planning opportunity involving discretionary trusts, as part of his series of articles about wills.
A will enables a testator to set out who he/she wishes to inherit his/her property on death. However, a testator may not always know for certain who should inherit what and the consequent inheritance tax (IHT) consequences on death may not be known with certainty.
An example would be where the testator, a sole trader, wishes to leave his business to his son but is reluctant to do so unless he can be certain that business property relief for IHT purposes of 100% will be available; otherwise, to avoid any IHT charge, the testator would leave the business to his surviving spouse.
Where such uncertainties exist, it may be a good idea for the testator to leave the whole of his estate or a large proportion on discretionary trust under his will.
Example 1: Flexible planning for the future
Henry Confused has three children. His wife has been adequately provided for, and he wants to provide for his children in his will. However, he has no idea as to what the future holds for each of them, and cannot therefore decide exactly what to leave each of them.
He therefore leaves a significant sum of money on discretionary trust with the three children being potential beneficiaries. Under the terms of the trust the trustees have discretion as to how much and when each child should receive monies from the trust in the light of future events and their future circumstances.
In the above example, typically, the trust will remain in existence for as long as the trustees feel they have a role to play. Depending upon the size of the estate IHT may have been paid on it. Similarly, IHT charges may arise as and when the trust monies to the children and when the trust is finally wound up.
However, if the trustees effect distributions to the children within two years of the date of death of the testator, the legislation provides that no IHT charges arise on the part of the trust (which would normally be the case). In essence, the legislation assumes that the testator provided for the distributions to be made directly to the children, thus effectively ignoring that the trust ever existed. The quantum of the original IHT charge on Henry’s estate, however, remains the same.
Example 2: Avoiding the IHT charge on trust appointments
Barry Clear has left all of his property on discretionary trust for the benefit of his wife and two children.
After his death his wife and children, following discussions, agree that there is no point in keeping the trust as matters have changed from the date Barry executed his will and therefore agree with the trustees that they should appoint all the property out amongst them in amounts agreed between them.
In order to avoid any possible IHT charges on the part of the trustees, they effect distributions within two years of Barry’s death. The original IHT payable on Barry’s estate may be reduced to the extent that distributions are made to his wife (due to the inter-spouse exemption).
It may be that the testator leaves his estate on discretionary trust for the benefit of his wife and children (as Barry above did). However, following death, his children may feel that they are each self-sufficient and that they would have preferred it if their father had left everything to their mother.
Example 3: Avoiding IHT completely
Herbert Small left an estate worth £525,000 on discretionary trust for his wife Susan and his children, Bob and Barbara.
Herbert had no nil rate band available on his death and thus IHT of £80,000 arose (i.e. 40% of [£525,000 - £325,000]).
Bob and Barbara are horrified at the size of the IHT charge.
Bob and Barbara feel that their mother should take all the trust property and so eighteen months after Herbert’s death the trustees appoint the money left in the trust to Susan.
As the distribution is made within the two year period the legislation effectively assumes that Herbert had left this amount directly to his wife (and nothing to the children) which means that the inter-spouse exemption applies and no IHT charge arises on Herbert’s death. Thus, the £80,000 charge is avoided; it is reclaimed from HMRC; and the wishes of the wife and children have been implemented as they wanted.
Capital gains tax
Although the use of the discretionary will trust may prove IHT effective, a possible capital gains tax charge may arise if the asset(s) in the trust (e.g. shares) has appreciated in value between the date of death and the date the trustees appoint the asset(s) out of the trust (the trustees being deemed to have made a disposal of the asset(s)).
Practical Tip :
Possible use of a will discretionary trust is always worth thinking about; but beware the two year deadline within which the trustees must act if any IHT saving is to be achieved.
