Planning a Tax-efficient Will
| Author | Lesley King/Peter Gausden |
| Pages | 195-206 |
17.1 Introduction
For most people, the overwhelming priority when planning a will is to make the best provision possible for close family members, typically their spouse, civil partner, cohabitee, children and grandchildren.
Finding ways of reducing the inheritance tax payable on the estate is important because it increases the amount available to the family. However, few people want to get involved in complicated or costly tax planning exercises. There are some relatively simple tax strategies which can help when planning wills and this chapter looks at the most important. These commonly involve the use of trusts or planning to make best use of the RNRB.
There are some case studies in Appendix 3 which put those strategies into effect.
17.2 Using trusts
When property is settled we often talk about a ‘trust’ of the settled property but, strictly speaking, property is held in a ‘settlement’; the particular terms on which it is held are the trusts. However, we use the term ‘trust’ as it is rather more user friendly.
Many people dislike the idea of trusts regarding them as complicated and expensive. However, they can be exceptionally useful. They provide flexibility where testators are not sure precisely how to leave their property and, in some cases, they can achieve tax advantages.
There are four main types of trust that can be created on death:
(a) discretionary trusts (and other trusts where no one has a present entitlement, such as trusts creating contingent interests);
(b) trusts with an immediate post-death interest;
(c) trusts for a bereaved minor;
(d) trusts for a bereaved young person.
196 Wills: A Practical Guide
In a book of this length we can do no more than give an outline of the key features of each trust and its possible uses.
17.2.1 Discretionary trusts
Distinguishing feature
These are the most flexible type of trust. The trustees hold the assets for the benefit of a class of beneficiaries, for example ‘my grandchildren’, and have power to apply income and capital amongst the beneficiaries at their discretion.
The trust can last for up to 125 years at which point any remaining assets must be distributed. In general, trusts will come to an end much more quickly.
Testators will normally leave a letter of wishes setting out their hopes and expectations and the matters they would like the trustees to take into account when exercising their discretions. The letter of wishes is in no way binding but conscientious trustees will take such wishes into account.
Discretionary trusts are very useful where the deceased wants funds to be used for the benefit of those in a class who turn out to have particular needs. Trusts with a contingent interest, for example for ‘my grandchild, Gabrielle, if she reaches 21’, are similar in that Gabrielle is not entitled to the trust property while she is under 21. However, once she fulfils the contingency, she becomes entitled. The will must provide for what is to happen to the property if Gabrielle dies under 21.
Inheritance tax treatment
From an inheritance tax perspective a discretionary trust is a relevant property trust; the funds held within the trust do not ‘belong’ to the beneficiaries and so the death of a beneficiary does not trigger a tax charge. The trust is a taxable entity in its own right. A trust with contingent interests like the trust for Gabrielle considered above is also a relevant property trust.
Every 10 years there is an anniversary charge on the value of the trust property. The maximum rate of tax is 6% and will often be much less. The rate is calculated by looking at the value of the settled property in the trust at the anniversary, at the settlor’s (i.e. the creator’s) cumulative total immediately before creation of the trust, which is inherited by the trust, and at the total of transfers from the trust in the previous 10 years.
There are also exit charges as property leaves the trust. These are calculated, using the rate from the previous anniversary, on the basis of the time that has elapsed since the previous anniversary. So an exit half way through a 10-year period would attract half a full charge.
In the first 10 years, exit charges are calculated only by reference to the settlor’s cumulative total and the value of the settled property put into the trust when it was created.
EXAMPLES
(a) Anniversary and exit charges
In June 2011, Dave died and left £300,000 to a discretionary trust for the benefit of his grandchildren and everything else to his wife. He had never made any lifetime transfers and so a full nil rate band is available to the trust.
In the first 10 years of the trust’s life, the trustees make income payments but no capital payments.
On the first 10-year anniversary, the value of the trust assets is £420,000 and the nil rate band has increased to £450,000.
There will be no charge to tax as the assets fall within the nil rate band.
If, in the following 10 years, the trustees start to make capital payments, the exit charge will be at 0% because the rate calculated on the previous anniversary was 0%.
(b) Transfers in the first 10 years
Maxine settled £300,000 on discretionary trusts for her children and grandchildren in June 2011. She had a full nil rate band available.
By June 2020, due to very successful investments, the assets have increased to £900,000; the nil rate band has risen to £420,000.
Where trustees distribute assets before the first 10-year anniversary, the rate is calculated on the value of the property originally put into the trust so, with the benefit of Maxine’s full nil rate band, all transfers will be taxed at 0%. If Maxine’s trustees wait until after the first 10-year anniversary, there will be an anniversary charge and subsequent exit charges.
The moral is always review the value of trust assets before the first 10-year anniversary.
Discretionary trusts are clearly attractive from the point of view of flexibility and can be used to shelter funds for young beneficiaries from inheritance tax. However, they are unattractive from an inheritance tax point...
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