DISCRETIONARY WILL TRUSTS

One planning technique that provides the necessary levels of access and control for the surviving spouse, while reducing the overall IHT liabilities, is a discretionary will trust.

A discretionary trust is established on death by the terms of the will. Assets of a value equal to the nil rate band in force at the date of death are held under that trust, subject to the control of trustees appointed in the will. 

The trustees have complete and unfettered discretion to permit the use of assets, and to appoint income or capital out of those assets, to any members of a class of beneficiaries defined in the will. It is traditional for the surviving spouse to be one of the trustees, to ensure the requisite level of control. Additional trustees may be family members or the family solicitor. The beneficiary class will normally be drawn as widely as possible, and includes the surviving spouse, thus satisfying the need for access.

Transfers into a discretionary trust are always chargeable to IHT, with the result that any assets devolving into the will trust will not be covered by the inter-spousal exemption. Once within such a trust, assets are outside the taxable estate of any individual, and will not therefore be subject to IHT as a result of any death. By arranging that the amount placed into the trust should shadow the available nil-rate band on first death, the amount of tax due on second death is reduced without triggering unnecessary tax liabilities on first death.

If the assets within the will trust are distributed out to beneficiaries within two years of death, the IHT position is the same as would have been the case if the trust had not existed: so that distributing any of the assets to the surviving spouse will effectively waste some of the nil rate band. 

If the assets remain under trust for more than two years, the trust comes within the normal taxing regime for discretionary trusts. There will be a periodic charge to IHT every ten years and an exit charge whenever capital is distributed out to beneficiaries. Since these charges are based on the excess of the trust capital over the current nil rate band, there is little prospect that any tax will actually fall due. In any event, even if the trust assets increase in value faster than the IHT threshold, the tax rate is only 6% per ten years. 

The most effective planning strategy for the use of a nil rate band discretionary trust is to retain assets within it for around twenty months after death, utilising any income generated for the maintenance of the surviving spouse. At that point, any assets that can safely be distributed to the children without damaging the financial security of the widow(er) may be distributed out – their value will continue to be covered by the deceased’s nil rate band. Other assets should remain within the trust until at least a full two years have elapsed – this will ensure that they too continue to utilise the nil rate band, even if eventually distributed to the widow(er).