About this series of articles
In this article, we continue to explain how you might use a trust in your will, with emphasis on basic tax planning as the law clearly applies. Before reading this, you might like to read more generally about different types of will trusts.
Note that tax law changes with every Budget (and sometimes more frequently). The figures used in this article are illustrative and are very likely to change. Always look up tax rates directly from HMRC's website and bear in mind that although what is discussed in this article has been valid for many years, the law may be different both when you prepare your will, and when you die.
A reference to a child means a person under 18 years of age. A reference to a partner means a registered civil partner.
Saving tax
'The only certain things in life are death and taxes', so let us make clear that there is no magic bullet to save tax.
Some advisers on wills may try to persuade you to enter into one of the tax schemes you see advertised in the newspapers. They may be paid commission when you join. We can say that any scheme to save tax is risky in that:
- it may not succeed under today’s law
- even if good now, the law may be changed before you die or make another will
- it is probably very expensive
- if it fails, the tax may be payable by some person who least expected the bill
Having said that, there are some ways of writing your will so that you are likely to pay less tax.
The nil rate band
If your estate - including any assets held in trust and gifts made within seven years of death - is above than a certain threshold, Inheritance Tax will be due at 40 percent on the amount over that threshold. From 6 April 2012 people who leave 10 per cent or more of their net estate to charity can choose to pay a reduced rate of Inheritance Tax of 36 percent.
For 2022/23, the threshold is £325,000. It is referred to as the Nil Rate Band or NRB.
There is an additional threshold called the Residence Nil Rate Band or RNRB. This threshold only applies if you leave a qualifying property (such as your home) to qualifying people (such as your children) but can increase your threshold by up to £175,000 giving you a total tax free allowance of £500,000.
If you have made gifts in the seven years before your death, the value is included, on a sliding scale, as if the gift had been part of your estate on death.
It follows that the best way to avoid inheritance tax is to give away your estate before you die!
For simplicity, we do not refer constantly to the possibility of life time gifts having been made. We take it you will remember to add them into your own calculations.
Some assets are down-valued for inheritance tax. The category includes business assets and shares in a private company. As ever, the rules are complicated. You should refer to your accountant or the HMRC's microsite on inheritance tax.
From October 2007, spouses and partners are treated as sharing a double helping of nil rate bands. The effect is that if the nil rate band was not used when the first spouse partner dies, it becomes automatically allowable as an addition to the nil rate band of the second to die. The transfer operates even if the first to die has died before October 2007.
In the estate of the second to die, any increase in the nil rate band is ignored for the purpose of determining whether the estate as a whole is subject to tax.
If the nil rate band changes between the two deaths, the amount carried forward as an allowance is calculated as a percentage of the allowance and not as an absolute sum.
Using a discretionary trust
A nil rate band discretionary trust as used before October 2007, is now ineffective to save tax. However, it can still be useful to use a discretionary trust. Here are some advantages you might like to consider:
- Because assets placed in trust are not owned by the surviving spouse or partner outright, they are not available to fund compulsory, means tested care fees.
- Assets left to the survivor outright could be spent or given away or taken by creditors or by a new spouse and so on, and so not be available for the intended original beneficiaries (likely to be the children of the first to die).
- The investments you place in a nil rate band trust may increase in value much faster than the nil rate allowance each year. So, by having placed then in a nil rate band trust, a greater value is free of tax than if the same investments were given to the survivor absolutely (no trust).
Of course, there are many possible reasons to use a trust that are unrelated to saving tax. If you want a trust anyway, the above points count as a possible bonus and the points below may be unimportant.
Disadvantages include
A point often ignored by professional advisers is the cost of setting up and managing a trust. Even using a Net Lawman will, accountants will charge for setting up the new account, book keeping and management, and correspondence each year. Only you can decide what level of cash or other benefit you need in order to justify this expense of time and money.
The surviving spouse or partner no longer has absolute power over management of the assets in trust. He or she must obtain the approval of the trustees to any expenditure of trust money or the sale or purchase of any asset, such as the house he or she lives in.
If you use a simple will to leave your entire estate to your spouse or partner, then 100% of your allowance could be claimed by his or her executors. If the nil rate band had risen in the meantime, then the percentage calculation system would give that second estate a double amount, tax free. However, there are likely to be few people with circumstances where this would be chosen.
Note: The carry forward of the unused allowance to the estate of the second to die is not automatic. HMR&C will require detailed accounts of the distribution of the first estate before they will agree the concession.
You can read more about the role of trustees in a will trust and life interests, debts and taxes.
The two year concession: covering an unknown future
Governments and circumstances change. You may not remember to draw a new will each year. Your loved ones may die before you, divorce, disappear, go bankrupt. How do you cover that? Well of course, you cannot see the future, let alone change it. But there is one way you can give great flexibility to your executors and beneficiaries to divide your estate in the way that you now and they then, think best.
If you place assets in a discretionary trust created by your will, your executors have two years from the date of your death within which to allocate and transfer those assets to your beneficiaries. They can even transfer them into other trusts (but with no further two year period). This arrangement is known as a '2 year discretionary trust'.
The key points are:
- You should appoint trustees who are competent and trustworthy and represent the interests of different sets of beneficiaries.
- You should use a will where the trust powers are drawn to give the trustees maximum freedom to manage all of your assets.
- You can use more than one trust, so use a second one, for example, to empower your guardians to look after your infant children.
- You should instruct your trustees carefully in a letter of intent - the more you tell them about your assets, wishes and beneficiaries, the better they will be able to operate.
- It is essential that the pool of discretionary beneficiaries is sufficiently wide to avoid HMR&C claiming that you truly have an interest in possession trust. So include peripheral relatives, by name or by class.
What you might include in your letter of intent:
- tips about who to trust
- what deals and arrangements to watch
- what property to sell immediately and what to keep
- which of your children will best direct your company or other business affairs
- to spend money looking at further tax saving
- above all, tell your trustees what you intend to give to whom. Use percentages if possible, as values change
There is a balance to be found between giving clear instructions on the one hand and trying to manage your assets after you are gone, on the other hand. You can be pretty sure your wishes will not be followed to the letter, but this is as near as you will get to managing your affairs from beyond the grave.
A word of warning: avoid pitting one beneficiary against another. You do not want your life’s work to be tied up in litigation for ten years.
Many choices. What will you do?
Our strong recommendation, if you are happy with our key points above, is to use a discretionary trust for at least part of your estate and allow your trustees to do some post mortem tax planning. You can read more about trusts created through wills.
Further information
We recommend that you read about who to choose as your executors and trustees next.
We strongly believe that everyone should make a will. So as to encourage you to do so, we provide some of our more straightforward wills (likely to be suitable for most people) absolutely free with no catches or conditions. Download one of our will templates. We offer nine in total that together cover thousands of possible variations of wishes. If you are in doubt as to which to choose, our article on where to start will help you to decide exactly which suits you best.