Will trusts and their IHT treatment

A will trust is simply a trust set up under someone’s will. Such trusts may be set up for family reasons (allowing trustee decisions to be taken in the future in the light of a beneficiary’s circumstances at that time), and also with a view to the mitigation of any inheritance tax (IHT) charge arising on the testator’s estate.

 

For IHT purposes, will trusts may be classified into one of two categories of trust, namely discretionary/relevant property trusts or special trusts.

 

The discretionary/relevant property trust is subject to both ten-yearly IHT charges and exit charges (i.e. an exit charge is levied when trust property is paid out to a beneficiary). However, in practice many of these types of will trust are set up with assets from the testator’s estate of value no more than £325,000 (the current nil rate band threshold for IHT purposes). This has the effect of reducing (possibly to nil) any future ten-yearly IHT or exit charges on trust property.

 

A key advantage of the discretionary/relevant property trust lies in its flexibility.

 

The category of ‘special trusts’ comprises the immediate post-death interest (IPDI) trust; the age 18 to 25 trust; the bereaved minor’s trust; and the trust for disabled persons. It is only possible in the space available to make one or two general comments. However, it is probably fair to say that, in most practical circumstances, of these four types of trust only the IPDI trust offers any real IHT advantages.

 

A key advantage of the IPDI trust (i.e. one where a trust beneficiary possesses an interest in possession) is that on the death of the testator, if the IPDI beneficiary is the testator’s spouse, no IHT charge arises on the testator’s estate left to the IPDI trust. In essence, any IHT charge is simply deferred. By comparison, if the testator’s estate was left to a discretionary/relevant property trust, IHT would arise on the testator’s death on the excess of the estate over £325,000 at a rate of 40%, which could be significant.

 

The IPDI trust also has a significant advantage over the discretionary/relevant property trust for income tax purposes.

 

Unfortunately, the other three categories of special trust referred to above are dogged by complex and restrictive provisions/conditions, which are not easily satisfied and reduce flexibility. For example:

• An age 18 to 25 trust is one where a parent sets up a will trust with child beneficiaries under age 25. However, the only scenario where such a trust may prove IHT advantaged is where a child beneficiary of the parent testator has a high probability of dying under age 25. 
• The bereaved minors trust requires that the bereaved minor beneficiary becomes entitled to the trust property at age 18; an age at which most parents would not want their child to inherit any significant sum of money/property. By comparison, an age 18 to 25 trust would at least permit deferral of entitlement to age 25. 
• One might have thought that the disabled person’s trust would clearly be the ‘best’ trust for a disabled beneficiary; however, in practice, this is just not so. Invariably, a discretionary/relevant property trust is more likely to be the better option, as it offers much greater flexibility.

The use of a will trust should not be overlooked by a testator. The ‘best’ option will depend upon individual circumstances; but in many cases, the discretionary/relevant property or IPDI trust may offer pragmatic solutions.