Trusts have a variety of different uses in wills. Most of these are relatively well known by will writers, however there are times where very specific facts could warrant the use of a trust. In this regular feature of the newsletter we will cover situations where a trust could be recommended to a client that you might not have thought of.
This week, we will look at a situation where you may consider using a discretionary trust following the end of a short term right to occupy.
Frank is married to Emily. Both have separate finances to each other and have their own children from previous relationships. Frank owns their main residence which is valued at £700,000 and £100,000 in cash assets. Emily owns her former main residence valued at £600,000 in her sole name and £100,000 in cash assets.
On Frank’s death he wishes to use a right to occupy trust to allow Emily to live in the property for five years. After five years the property will be sold and the proceeds passed to Frank’s children. His residuary estate will also pass to his children.
What’s the problem?
There are no inheritance tax issues on Frank’s death if he dies first as the spousal exemption will apply to the gift to the right to occupy trust and his residuary estate would be below the nil rate band. When the right to occupy trust ends, for inheritance tax purposes it is treated as Emily making a potentially exempt transfer (PET) to Frank’s children.
If Emily dies within 7 years of the end of the right to occupy, inheritance tax would be payable on the failed PET. Emily’s NRB, along with any transferable NRB available from Frank, would be applied towards this failed PET firstly. Her estate may still benefit from the RNRB however as RNRB could apply to her previous home.
As Emily’s NRB and any unused transferable NRB would be applied to the failed PET to Frank’s children firstly Frank and Emily feel that in this situation, Frank’s children inherit disproportionately more than Emily’s children as Emily’s assets would need to pay more inheritance tax than his assets. As illustrated below if Emily dies two years after the right to occupy trust ends.
|Minus Transferable NRB (from Frank)||£225,000|
|Taxed at 40%||£60,000|
|Plus Frank’s Residuary Estate||£100,000|
|Minus IHT due||£60,000|
|Minus RNRB and transferable RNRB||£350,000|
|Taxed at 40%||£140,000|
|Minus IHT due||£140,000|
Despite Frank’s total estate being larger than Emily’s, how inheritance tax is applied on Emily’s death means that Frank’s children receive more than Emily’s children.
A discretionary trust could potentially be considered rather than a right to occupy trust, which would avoid the property passing into Emily’s taxable estate. However, this would cause some additional IHT concerns as IHT would be due on Frank’s death and an exit charge would be payable if the trustees distributed 5 years after Frank’s death. If the trustees decided to retain the property, there would also be anniversary charges payable on the 10 year anniversary of Frank’s death.
Alternatively, Frank could consider giving Emily’s children a share of the property when the right to occupy trust ends. However if Emily does survive 7 years so that the PET is successful the problem is potentially reversed so that Emily’s children now inherit disproportionately more than Franks.
Frank could consider including terms in his will so that when the right to occupy trust ends, a percentage of the sale proceeds passes to a discretionary trust with his children and Emily’s children as potential beneficiaries. If Emily does not survive 7 years from the end of the trust, the trustees of the discretionary trust could benefit Emily’s children to compensate the increased IHT liability on Emily’s estate. If Emily has survived 7 years the trustees could distribute to Frank’s children.
If you would like any further advice on this, please don’t hesitate to contact us at [email protected].