Will planning and trusts

 

Will provision for young children

If you intend to leave your assets to young children or grandchildren on your death, what’s the best way to do it?  Do you always need a trust? Some people may shy away from the idea of a trust and would rather “keep things simple”. In practice, an attempt to keep things simple may lead to unintended complications.

Outright legacies to minors

What happens if a will simply provides for a legacy of a fixed amount to go to a named child and, at the time of the testator’s death, the child is under age 18? This often happens when grandparents want to leave a sum of money to a grandchild. If the legacy is contingent on the child attaining a certain age, this brings with it its own problems – see later.

Section 3(1) of the Children Act 1989 enables a parent with parental responsibility to give a good receipt to the executors (so that they can just pay over the money to the parent) but it does not set out what powers the parent has to deal with the legacy. If there is nothing in the will specifying the powers of the parent to deal with the legacy, there will be an implied trust in any event. Clearly, it would be much better to use an express trust wording.

Outright, contingent or deferred gifts

Legacies may be absolute and outright (without any conditions) or may depend on, say, the child attaining a certain age. If there is no express trust, there will be an implied trust, but the question will be what kind of trust is it and whether the child is entitled to the income or not. If the gift is outright and unconditional and the child is a minor, there will be an absolute (bare) trust for the child. In other cases, it may not be so straightforward. Briefly, there is a problem with legacies to other than own children of the testator as such legacies do not carry the intermediate income.

So, if a legacy is expressed along the lines “£100,000 to my granddaughter Jane when she attains age 18” and Jane is now 5 years old, Jane will be entitled to the fixed sum on her 18^th birthday but not to the income on it or any growth.  Of course, the trustees will be obliged to invest the funds in the intervening period. The income and growth would belong to the residuary beneficiary under the will so the legacy will, in effect, create an IPDI (immediate post-death interest) in favour of the residuary beneficiary. This would mean that the value of this legacy will be included in the estate of the residuary beneficiary for IHT purposes and when Jane reaches age 18, the residuary beneficiary will be treated as making a PET in her favour.  It is unlikely that any testator contemplating a “simple” deferred gift would appreciate the potential consequences of such a provision. Clearly, all these problems would be avoided if a proper trust is included in the will.

However, if the testator is determined not to have a proper trust, then they should at least include the following clause in their will: “This legacy shall carry the intermediate income and until the legatee attains the specified age the trustees shall have power to accumulate the income and add it to the capital of the legacy fund”.

Trusts for bereaved minors (TBMs) and 18-to-25 trusts

All trusts created for a minor child on the intestacy of a parent will be TBMs while a will may create a TBM or an age 18-to-25 trust. Under a TBM the beneficiary must become absolutely entitled at age 18. Under an age 18-to-25 trust, the trust can continue beyond age 18 as long as the beneficiary takes the trust assets absolutely not later than age 25. TBMs are not subject to the IHT relevant property charging regime and age 18-to-25 trusts only become subject to the regime on payments out of the trust after age 18, with a maximum possible IHT charge at 4.2% on the latest possible distribution at age 25. There are no entry or periodic charges under an age 18-to-25 trust.

These trusts were introduced by the Finance Act 2006 and can only be set up on the death of a parent (including a step-parent) for a minor child.

Anybody else wanting to create a trust for a child in a will continues to have a choice of trusts but, unless the trust is an absolute one, the IHT and income tax consequences should be considered before deciding which trust they want.

Discretionary trusts, A&M trusts and IIP (interest in possession) trusts

Given that since 22 March 2006 no qualifying A&M trusts can be created, a fully discretionary trust will often be recommend (see below). After all, one can always make a trustless flexible but not the other way around. On the other hand, in real life situations, people are not always happy to give full discretion to the trustees. Most testators will in fact have a clear idea as to when (e.g. at what age) they would like their beneficiaries to benefit (it may be different when making a trust during lifetime when the settlor may retain control over this). This will often mean granting an entitlement at a certain age with a power to accumulate or distribute income if needed until then. While such a trust will no longer be a “qualifying” A&M trust for IHT purposes, neither will it be a “fully discretionary trust”.

It should be remembered that any will trust for a minor will give rise to a chargeable transfer for IHT on death; however not all trusts will be treated in the same way subsequently. An IIP trust will be an IPDI for IHT purposes and will benefit from income tax assessment on the beneficiary. Any other kind of trust (other than a bare trust) will be a relevant property trust for IHT purposes and subject to the higher trust tax rates in respect of trust income. All these factors should be taken into account when including a trust for minor children in a will to avoid later disputes.

Continuing value and usefulness  of discretionary will trusts

Until 2007 IHT planning for married couples had been founded on ensuring that full use was made of both nil rate bands (NRBs). However, since the introduction of the transferable nil rate band (TRNB) in 2007 the incentive to carry out such planning has significantly diminished.

Of course, there may be other reasons for using the NRB (and now the residence nil rate band (RNRB) on the first death of a couple. For example, where either spouse has previously been widowed, use of the NRB /RNRB on the first death may pave the way for use of a total of three NRBs/RNRBs rather than just two. In such cases, absolute gifts to children on the first death should generally not exceed the available NRB - any excess can pass to the spouse who can then make unconditional potentially exempt transfers to the children if appropriate.

Another situation when a use of the NRB on the first death would be appropriate would be when the house alone is valued at more than the total NRB amount likely to be available on second death (taking account of both NRBs and RNRBs) and there are no or insufficient other assets in the estate. In such a case a gift of a share of the property to children on first death might seem to be the easiest way to achieve this.

There will clearly be situations where there will be no need for a discretionary will trust, for example:

• Only one TNRB is available to each spouse (i.e. no previous marriages) and full control over the assets is needed for the survivor, especially where the assets of the couple are fully covered by their combined NRBs.

• No liquid assets in the estate – e.g. principal residence being the only asset that could satisfy the NRB legacy and so the additional inconvenience/expense of running a trust is not justified.

• No need for generational estate planning, e.g. all the assets to pass to charity on second death.

So, anybody with a pre-2007 will with NRB trusts in circumstances such as those listed above should consider making a new will. If a trust is included in a will and it is not in fact needed, there are ways to deal with it by making an absolute appointment - see below - but things will be much simpler for the executors after the first death if the will has already been updated to provide for an absolute legacy to the surviving spouse. And, obviously, updated will provisions will also avoid any debate after the testator’s death about whether “this was what he/she really wanted to happen”.

Good ongoing reasons for a discretionary will trust on the first death

There are many occasions when a NRB will trust may still be appropriate:-

(i)        The spouses may each be in a second marriage and each of the couple may wish to benefit his/her children from a former marriage on the first death or it may just be that each of the couple does not want the survivor to have complete legal and beneficial control of the assets following the first death. Whilst this could technically be achieved using a life interest trust  (IPDI) in the will (with income payable to the surviving spouse and capital held for the children from the first marriage), that route lacks flexibility, especially if there is an intention to make capital payments to the widow/widower by way of interest-free loans.

(ii)       There may be a desire to avoid assets being available to the local authority in the event of the survivor going into care. By leaving assets to a trust on the first death those assets will not count as part of the surviving spouse’s resources for the purposes of the local authority charge.

(iii)      It may be desired to avoid children inheriting assets outright. Passing assets to them via a trust will mean that they are protected from the claims of creditors and ex-spouses.

(iv)      Further IHT savings could be secured by the trustees of the will trust making loans to the surviving spouse, if and when funds are needed, which create debts and so reduce the taxable estate of the survivor on his/her subsequent death (as long as the debt is repaid on the spouse’s death).

(v)       We have already mentioned above the possibility of using a third NRB where a person has remarried after his/her former spouse has died without using his/her nil rate band.

Finally, remember that even if a discretionary will trust does come into existence on the first death and, after the first death, this is not required, there would, within 2 years of death, be scope to appoint absolutely out of that discretionary trust and achieve the same IHT results as if the asset had passed directly under the will. In particular, an appointment can be made absolutely to the spouse or to a life interest trust under which the spouse has an interest in possession and, in both these cases, the spouse exemption will apply. Clearly, putting an NRB trust in your will means effectively hedging your bets. However, you need to trust your trustees to do the right thing. Remember the importance of a letter of wishes.

Charitable legacies – points to remember

It is well known that gifts to registered charities are free from IHT, and not only that but if a sufficiently large legacy is left, the tax on the remainder of the estate is reduced to 36% under Schedule 1A Inheritance Tax Act 1984. It seems straightforward except that it is important to remember what a charity is for this purpose.

In Routier v HMRC [2019] UKSC 43 (16 October 2019), the Supreme Court, reversing the decision of the Court of Appeal from 2016, found that a donation to a charitable trust established in Jersey was exempt from IHT. So the locality of the charity may not be relevant.

However, what is equally if not more important is to ensure that the name of the charity is correct.

In the recent case of Knipe v British Racing Drivers’ Motor Sports Charity [2020] EWHC 3295 (Ch)) the executors had to apply to the High Court for a declaration as to who should be the beneficiaries of two charitable legacies because the testator described the organisations incorrectly. The Court had to examine the history of the testator's relationship with the said organisations and, interestingly, in relation to the legacy to the “Cancer Research Fund”, given that at the relevant time there were four charities with similar names, the Court decided that the legacy was to be applied for the general charitable purpose of cancer research rather than going to a specific charity. Obviously, having to go to Court for an interpretation will involve costs and a time delay so should be avoided. Especially now, as one of the effects of the pandemic is a huge backlog of Court cases. Precise wording and the use of correct names will avoid any doubts.

The final thing to remember is to ensure that the will clause dealing with any charitable legacies is drafted appropriately to ensure that the 10% tax reduction applies. To this end, it may be useful to utilise a model clause leaving the minimum amount to charity required to qualify for the reduced rate. There are drafts available from STEP and from HMRC.

Comment

Many would have seen a recent story that in 2013 the actor George Clooney decided to hand out $1M each to 14 of his friends who were “in his will” (rather than waiting “to get hit by a bus”).

There is a less well-known story about the great French philosopher, Michel de Montaigne, who died in 1592. When he felt he was close to death, he is said to have got up from his bed in his nightshirt, called all his servants and all those to whom he was leaving legacies under his will, and instead he proceeded to pay to each of them their bequests. This was supposedly to avoid any difficulties his executors might raise against satisfying his wishes after his death. Now, that is a perfect method of avoiding anybody disputing your will, if there ever was one. Seriously though, with the possible introduction of a wealth tax on the horizon, reducing one’s estate by accelerating legacies (AKA making lifetime gifts) is surely something to raise with clients ahead of the forthcoming  Budget.

We will deal with pilot trusts and same-day additions next month.