Leaving money outright via a Will
Leaving money to a spouse in this way has the advantage of being very straight forward and allows the surviving spouse to have complete access to the funds.
As there is no Inheritance Tax between spouses, there is no tax liability on the first death and since the introduction of the transferable nil rate band, the unused nil rate band of the first spouse to die can be subsequently used on the second death.
The nil rate band is the amount of a person’s estate which is not subject to Inheritance Tax. Everyone is automatically entitled to the nil rate band. Since 2007, it has been possible to transfer any unused part of a nil rate band from a deceased spouse or civil partner, up to a total of one additional nil rate band (£325,000). It is only transferrable between spouses or civil partners and must be claimed via HMRC’s IHT402 form – it is not automatically applied. This means that on the second death of a married couple, the deceased’s estate could claim up to £650,000 of the nil rate band.
So, if leaving assets directly to a spouse on first death is simple and tax-efficient, with no loss of the nil rate band, why is it sometimes sensible to use a trust?
Passing on money via a trust
Some people are concerned about what will happen to the assets left to the surviving spouse on the first death should that surviving spouse remarry. The surviving spouse could leave all of the assets to their new spouse, potentially excluding any children from the first marriage. This could happen inadvertently, as marriage revokes any former Will and intestacy rules will always prioritise a surviving spouse over a child. If, however, the assets are placed into a trust, the trustees can protect the assets held within it.
Interest in possession trusts
On the first death, a trust can be established under the Will. Under this trust, the surviving spouse has the right to any income arising from the estate and/or a right to occupy the family home. This is known as an interest in possession. The right to give the spouse capital payments can also be included. On the death of the surviving spouse, the trust assets can then pass to children from the first marriage, or any other intended beneficiary.
The value of the assets are deemed to pass to the person with the right to income (the surviving spouse in this instance), as the assets in the trust form part of the estate of the person with the interest in possession. This means there is no Inheritance Tax payable on first death due to the exemption for passing assets to spouses. If this arrangement is used, the transferable nil rate band can still be used on the death of the surviving spouse.
This type of trust also has the benefit of protecting the capital from assessment by local authorities for long-term care purposes.
Another type of trust that can be used in a Will is a discretionary trust. As the name suggests, under a discretionary trust, the trustees have discretion over which beneficiary benefits from the assets held within it and when.
Often a discretionary trust, up to the value of the available nil rate band, is established on the first death of a married couple. This ensures no Inheritance Tax is payable because the value is below the nil rate band and the assets in the trust do not form part of any beneficiary’s estate. The beneficiaries under the trust could include the surviving spouse and children and assets could be passed to them as and when required.
Any growth in the assets within the trust falls outside of the estate of the survivor. This means that if between first and second death the growth in the discretionary trust exceeds the growth in the nil rate band, less Inheritance Tax should be payable on the second death.
Discretionary trusts can also be used to protect the assets if the surviving spouse remarries, to shelter the assets if the survivor needs to go into care, to reduce the size of the surviving spouse’s estate on their death to avoid their residence nil rate band being tapered down, or even to reduce the Inheritance Tax liability of the next generation by creating a trust which they can access but does not form part of their estate.
Considerations for putting assets into trust
Before putting any assets into trust, care needs to be taken, as trusts are potentially liable to tax themselves and the complexity of running the trust will depend on what is held within them.
Whether or not a Will trust is suitable will depend upon individual circumstances. Factors such as the size of the estate, the family situation and how important protection and control of the assets are all need to be taken into account. Professional guidance is normally advisable before any decisions are made.
Talk to Evelyn Partners
Our experts are here to help with all aspects of your estate and Inheritance Tax planning, including your options for passing on your assets. To see how they could help you, book a free initial consultation online or by calling 020 7189 2400.
Advice in relation to trusts and inheritance tax planning is not regulated by the Financial Conduct Authority, however, the products used in relation to trusts and to mitigate tax may be regulated.
This article was previously published on Tilney prior to the launch of Evelyn Partners.