Nil Rate Band Discretionary Trust Wills
What is the Purpose of Discretionary Trust Wills?
The object of a discretionary trust Will is to use up the Inheritance Tax free threshold or ‘Nil Rate Band’ of the first person in a marriage or civil partnership to die (Note 1). The threshold is currently £285,000 and every person is entitled to benefit from it. By doing so you could save up to £114,000 in Inheritance Tax.
Why are Discretionary Trust Wills Important?
If spouses simply make Wills in which each one says that if he/she dies first the survivor is to have everything that is exactly what will happen. However, anything passing from one spouse to the other is free of tax anyway so the opportunity to use the tax free threshold on the first death is wasted.
Instead, spouses could say "if I die first, I want assets up to the Inheritance Tax threshold in value to go direct to the children or into trust for the children". This would effectively use up the Inheritance Tax free threshold on the first death but for many spouses this is impracticable because it would or might leave the survivor short.
So many spouses prefer to make Wills with a discretionary trust to operate on the first death. It is capped to the Inheritance Tax threshold and it has the surviving spouse as well as the children as potential beneficiaries. The object of the exercise is that assets up to the Inheritance Tax free threshold go on the first death into the discretionary trust. The survivor cannot be the only beneficiary (or it would not be a discretionary trust and it would be taxed on the survivor’s death) which is the reason why the children and grandchildren are named as potential beneficiaries too. In reality you choose trustees who completely understand that the survivor is to have anything that he or she wants to have from the trust income and capital for the rest of his/her days (to include having the whole of the capital if that is what the survivor wants).
Then anything left on the death of the survivor goes out tax free to the children.
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Putting the Impact into Perspective | |
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A surviving spouse owns assets worth £570,000.00 and has four children who will share the estate on his or her death | |
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Without Nil Rate Band Discretionary Trust Wills IHT payable: £114,000.00
Child One Receives: £114,000 Child Two Receives: £114,000 Child Three Receives: £114,000 Child Four Receives: £114,000 |
With Nil Rate Band Discretionary Trust Wills IHT payable: NIL Child One Receives: £142,500 Child Two Receives: £142,500 Child Three Receives: £142,500 Child Four Receives: £142,500 |
The only downside of the discretionary trust is that the survivor cannot be in complete control of the assets in the trust. The survivor can be one of the trustees but cannot be the only trustee (or it would not be a discretionary trust) so there has to be at least one other trustee and the survivor has to get that other trustee to agree before he/she can have whatever he/she wants from the trust.
Some people regard this limitation on their control of the situation as annoying so under the present law, it is usual to include IOU powers in the discretionary trust clause which gives the survivor the right to give the trustees of the discretionary trust an IOU to pay the trustees the amount of the Inheritance Tax threshold. All the assets belonging to the first to die can then be transferred over to the survivor who holds them outright. The IOU remains outstanding for the rest of the survivor’s days. On the death of the survivor the IOU is paid out of the survivor’s assets to the trustees of the discretionary trust (so the same tax saving is achieved). The trustees of the discretionary trust then pay the sum they have received out to the children.
The discretionary trust clause will usually specify 80 years as the period of the trust. This is not in the expectation that the trust will last for that long. Eighty years is the maximum period that the law allows a discretionary trust to last. In reality, on the death of the survivor the trust will be brought to an end and the trust assets divided equally between the children (unless one of them is going through a messy divorce or bankruptcy in which case the assets will be held within the trust until the danger period has passed).
A Letter of Wishes is used to remind the trustees of these priorities.
Note 1: The term 'spouses' in this document is used to describe civil partners as well as husband and wife
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