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Discretionary Trust, Wills & Inheritance Tax
Discretionary Trusts - continued

Discretionary Trust, Wills & Inheritance Tax

Although any unused nil rate band is transferred to a surviving spouse or civil partner, making provision for a discretionary trust in your will could still be worthwhile.

How do the inheritance tax rules work?

The first slice of any individual’s estate, including gifts that they have made in the last seven years, is generally free of inheritance tax. This slice, referred to as the ‘nil rate band’, was increased to £325,000 from 6th April 2012. Inheritance tax is charged at 40% on the amount that exceeds the nil rate band.

Any unused nil rate band can now be transferred to a surviving spouse or civil partner. This means that where the second death occurs on or after 9th October 2007, the benefit of any unused nil rate band on the death of the first spouse is transferred to the estate of the surviving spouse, even where the first death occurred before 9th October 2007.

The amount of the nil rate band potentially available for transfer will be based on the proportion of the nil rate band that was unused when the first spouse died. The following examples explain how this works:

Example 1

On the first death none of the original nil rate band (say £150,000) was used because the entire estate was left to a surviving spouse and benefited from the spouse exemption. If the nil rate band when the surviving spouse dies is £325,000, the available nil rate band on the second death would be increased by 100% to £650,000.

Example 2

If on the first death the chargeable estate is £150,000 and the nil rate band was £300,000, then 50% of the original nil rate band would be unused. If the nil rate band when the surviving spouse dies is £350,000, then the total nil rate band available on the second death would be increased by 50% to £525,000.

The amount of nil rate band that can be accumulated by any one surviving spouse is limited to the value of the nil rate band in force at the time of their death. This means the maximum anyone is entitled to is double the nil rate band on their death.

Why include a discretionary trust in your will?

Previously, well advised couples might have included a discretionary trust in their will to utilise the nil rate band on the first death rather than wasting it by passing assets to the surviving spouse under the spouse exemption. Although any unused nil rate band can now be transferred to the surviving spouse or civil partner, there are still circumstances where this type of planning remains beneficial.

These circumstance include:

  • complex succession plans, particularly where there is a second marriage and/or step children
  • estates containing assets where the value is expected to grow faster than the anticipated future increases in the nil rate band allowance
  • estates containing assets eligible for business property relief or agricultural property relief.

What is a discretionary trust?

A discretionary trust is a very flexible type of trust. The trustees of the trust own the trust’s property on behalf of the beneficiaries. The beneficiaries need not all even be born at the time the trust is created.

The trustees can pay out income or capital to any one or more of the beneficiaries entirely at their own discretion. No beneficiary has a right to demand income from a discretionary trust.

How do I provide for the survivor?

The surviving spouse or civil partner can be included as one of the beneficiaries of the trust. The trustees can be empowered to pay out income or the underlying capital to the surviving spouse or civil partner at their discretion. Thus the surviving spouse or civil partner can enjoy both the income and capital of the trust.

How do you guide the trustees?

This is usually achieved by leaving a ‘letter of wishes’ with the will. Such letters are quite usual and are read alongside the will, though they are not binding on the trustees. It is quite normal for such a letter to state that the first aim for the trust is to ensure adequate provision is made for the surviving spouse or civil partner for the remainder of his or her days. The letter will usually say what is desired to happen thereafter, such as passing assets to the children.

How does the trust operate?

The executors will pass the assets that are to be the trust property to the trustees. Very often, the trustees are the same people as the executors. In this case, they simply own the property as trustees as opposed to holding it as executors.

The trustees will then need to register the trust with HM Revenue and Customs (HMRC) who will send a short form for the trustees to complete. This enables HMRC to register the trust.