Planning for unmarried couples often involves a careful balance between providing security and preserving inheritance for the next generation. A common request is to allow a surviving partner to remain in the property for a short period of time, while ensuring that it ultimately passes to children. In these circumstances, the question is often whether a Right to Occupy or Discretionary Trust is the more better solution.
This article is a case study covering this type of situation based on recent real advice provided by WillPack.
Right To Occupy or Discretionary Trust: The Background
Mr Platt is divorced and in his 60s. He has two adult children and has been in a relationship with Joan for the last five years.
The couple live together in Mr Platt’s home but have no plans to marry. Joan owns her own property, which is currently rented out, and both parties keep their finances separate.
Mr Platt’s wishes are relatively simple. He wants his estate to pass equally to his two children. However, if Joan is still living with him when he dies, he would like her to have some time to make alternative arrangements before the property is transferred to his children.
His estate consists of:
- Home: £400,000
- Other assets: £300,000
- Total estate: £700,000
Ideally, Joan would be able to remain in the property for approximately 18 months after Mr Platt’s death, provided she pays the day-to-day outgoings.
The Obvious Option: A Right to Occupy
The most obvious solution is to give Joan a Right to Occupy the property.
Under this arrangement, Joan would be entitled to remain in the property for a specified period of 18 months or until she vacates. At the end of that period, the property would pass to Mr Platt’s children.
From a practical perspective, this appears to achieve exactly what Mr Platt wants. Joan receives short-term security and the children ultimately inherit the property.
Right To Occupy Inheritance Tax
The difficulty is that a Right to Occupy will most likely be taxed as an Immediate Post-Death Interest (IPDI). Joan as the life tenant of that trust would be considered as inheriting the property for inheritance tax purposes, even though she only has a temporary right to remain there.
This matters as it will impact the availability of the Residence Nil Rate Band. This is only available where a qualifying residential interest passes to direct descendants, such as children or grandchildren.
If the property is treated as passing to Joan first due to her Right to Occupy, the Residence Nil Rate Band will not be available on Mr Platt’s death.
On that basis, inheritance tax with a Right to Occupy would be calculated as follows:
- Estate: £700,000
- Less Nil Rate Band: £325,000
- Taxable estate: £375,000
- Inheritance tax at 40%: £150,000
There can also be further inheritance tax consequences for Joan. When the Right to Occupy ends, the termination of that interest will be treated as a transfer by Joan for inheritance tax purposes. If she dies within seven years, the value of the property will need to be taken into account when calculating inheritance tax on her own estate.
Before deciding between a Right To Occupy or Discretionary Trust, it is important to understand how the inheritance tax treatment differs. Although both options can provide Joan with short-term security, the long-term tax consequences may be very different.
A Possible Alternative: A Discretionary Trust
An alternative approach is to use a Discretionary Trust.
A Discretionary Trust does not give any beneficiary a fixed entitlement. Instead, the trustees decide who benefits, when they benefit and how they benefit.
The potential beneficiaries could include Joan and Mr Platt’s children, grandchildren and remoter descendants.
The trustees could exercise their discretion to allow Joan to remain in the property for up to 18 months following Mr Platt’s death. During that time, they might require her to pay expenses such as council tax, utilities and maintenance costs.
After that 18 month period, or if she vacates earlier, the trustees could transfer the property to Mr Platt’s children.
The Residence Nil Rate Band Advantage
At first sight, a Discretionary Trust appears to create its own problem because the property is not passing directly to the children on death and will instead be passing to a relevant property trust.
However, section 144 of the Inheritance Tax Act 1984 can assist.
Where trustees make a distribution from a Discretionary Trust within two years of death, that appointment will be ‘read back’ and treated for inheritance tax purposes as if it had been made by the will itself.
This means if the trustees appoint the property to Mr Platt’s children within two years of death, for inheritance tax purposes the children were treated as inheriting under the will. This will allow the Residence Nil Rate Band to be claimed retrospectively.
At the point of death, the inheritance tax charge will remain £150,000. However once the trustees distribute the property to children within two years of death and Residence Nil Rate Band is available:
- Estate: £700,000
- Less Nil Rate Band: £325,000
- Less Residence Nil Rate Band: £175,000
- Taxable estate: £200,000
- Inheritance tax at 40%: £80,000
In this example, the potential inheritance tax saving is approximately £70,000.
The Downside
The main disadvantage of the Discretionary Trust approach is certainty.
With a Right to Occupy, Joan has a clear legal entitlement to remain in the property for the specified period. With a Discretionary Trust, she does not and relies on the trustees exercising their powers to allow her to live there.
This concern can be addressed through careful trustee selection and a strong letter of wishes. Whilst a letter of wishes is not legally binding, it provides useful guidance to the trustees.
Right to Occupy or Discretionary Trust: Conclusion
For unmarried couples, will planning often involves balancing family protection against inheritance tax efficiency.
A Right to Occupy may appear to be the simplest solution. However, where it creates an IPDI, it may prevent the Residence Nil Rate Band from applying. A Discretionary Trust can provide a more flexible and tax-efficient alternative to a short term Right to Occupy by allowing the possibility of claiming the Residence Nil Rate Band through a section 144 distribution within two years of death.
There is no single answer to whether a Right to Occupy or Discretionary Trust is the better solution. The most appropriate structure will depend on the client’s priorities, the family circumstances and the potential inheritance tax implications.
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This article is provided for general information only and does not constitute legal advice. Any wording or clauses referred to are illustrative and should not be relied upon as precedent without full consideration of the client’s circumstances, the will as a whole, and the law in force at the relevant time.
