Will Trust Arrangements

The following is an example of possible Will trust arrangements for a married couple, including tax considerations. Note that these Will trust arrangements should not be confused with any information received in relation to setting up a trust in lifetime.

Will trusts are not caught by the Scottish Government’s Guidance to Local Authority (CRAG) rules and do not offend against that guidance in terms of “deprivation” of assets.

Inheritance Tax

In terms of inheritance tax, each married partner has a “nil rate band” or allowance of £325,000. Rules introduced in 2007 allow the unused proportion of the nil rate band of the first spouse to pass to the surviving spouse so that up to £650,000 at current rates would be available before inheritance tax would be paid at 40% on the second estate on any balance (net estate) exceeding this double allowance – unless a Discretionary trust arrangement is included in the Will, which can use up the nil rate band of the first spouse to die, see below.

These can be written in a number of different ways and can cover both heritable property and/or moveable estate. Heritable property is land or buildings and moveable property is basically anything else and would include an interest in a business.

Q: What rights does a liferenter have?

A: The “liferenter” has the right to the use and enjoyment of something i.e. income and dividends from shares or investments and/or quite commonly the right to occupy a property for life or until the happening of a specified event e.g. remarriage or going into long term care. You can specify the conditions and period of the liferent.

The default position is that the liferent does in fact last for life, although no rent is payable. If a liferent is used it is also wise to specify in the Will/trust who will be responsible for arranging and paying insurance, maintenance and other costs.

The beneficiary of liferented property is treated as owning that property for Inheritance Tax purposes, so that on their death the liferented fund is aggregated with their estate in order to assess any tax payable.

A liferent in a Will does not use up the nil rate band or Inheritance Tax allowance of the first spouse to die (unlike a Discretionary Trust), therefore up to two nil rate bands remain available on the death of the second spouse. Of course tax rules and allowances can change, therefore Wills should be reviewed regularly.

Another solution might be to incorporate a discretionary trust into one or both Wills. A discretionary trust usually has three trustees and names a number of potential beneficiaries, usually the surviving spouse and other relatives; whether children, siblings, parents or other.

The crucial point is that no particular beneficiary has a right to receive any particular part of the trust estate. The decision as to whom should benefit and to what extent must be made by the trustees. They however can be guided by a side document know as a “memo of wishes” by the testator.

The memo cannot fetter the discretion of the trustees, but will state in the testator’s own words what they want to happen to their estate on their death and what their wishes and objectives are. The trustees can make distributions to beneficiaries outright or on further trusts, including liferents.

A discretionary trust offers flexibility. The trust is treated as a separate entity for Inheritance Tax purposes and as such can pay further tax if the value of the assets or investments held in the trust exceed the level of the nil rate band. The maximum rate of tax however is 6%. If the assets held do not exceed the Nil rate band threshold (currently £325,000) then there will be no further charge to Inheritance Tax, although other taxes may apply e.g. income or capital gains.

The Will could state specifically that the trust should be set up for an amount not exceeding the nil rate band level. The trust in effect “uses up” the nil rate band of the first spouse so that it does not transfer to the second spouse. The second spouse however still has their own nil rate band of £325,000. Such a trust can include a share in the house as well as other investments.

As stated above, the trustees make the decisions about who benefits and to what extent. They could even make over the entire estate after first death to the surviving spouse if that is considered by them (guided by the “memo”) to be the best course of action.

Loans can be made from the trust to any one or more of the beneficiaries and the trustees can require an “IOU” in return. This means that if the loan has not been called up beforehand, on the death of the surviving spouse the amount of the IOU is repaid to the trustees of the first spouse to die, thereby reducing the value of the estate of the second spouse (because of the “debt”).

The sum repaid from the second estate back to the first therefore effectively secures or “ring fences” the estate going forward to the next generation. However, consideration needs to be given to funds remaining in the estate of the borrower and their ability to repay or give security.

You can in fact include both for different assets in your estate. Some clients prefer liferents because they feel this is more definite from the outset rather than leaving the decision to trustees. Liferents leave the nil rate band of the first spouse free to pass to the surviving spouse, entitling the estate of the second spouse to benefit from a double tax band – a total of £650,000 at current figures.

More flexibility can be introduced into liferents e.g. by giving trustees the power to make advances out of the fund/assets, particularly if the liferenter has insufficient income or capital of their own. There is sometimes a balance to be struck between preserving assets going forwards and making sure that adequate provision is made for the “liferenter”, who is usually a spouse or longterm partner.

If there is a liferent created over a share in a house, it can be carried forward to a future property. It is therefore portable and does not necessarily mean that the surviving partner cannot move to a property which better suits their needs in terms of location, size etc. Discretionary trusts however are generally wider.

The inheritance tax position of each type of arrangement should be carefully considered. The important point is that trusts can be useful in a variety of circumstances, and especially if you want to have more control over assets going forwards to your children. They can preserve your estate against the possibility that your spouse may remarry or pass their estate to someone who is not associated with you/in a way you did not anticipate. They can also preserve your assets against the impact of care fees if at any time in future you need long term care. Your Will can be as simple as you wish it to be.

You might decide not to make use of either of the trust arrangements mentioned here, but it is important that you are aware of all the options.

Contact David Johnson

For help with trusts, tax planning or related legal advice, please contact David ohnson on 0131 622 9222