This article is based on recent client advice and reflects a question that comes up often in practice, considering the use of will trusts for protecting inheritance. Many clients wish to ensure that their estate ultimately benefits their children and wider family, rather than being exposed to risks arising from third party claims on family members.
Will trusts can be an effective solution. This often involves a combination of discretionary trusts and residence nil rate band life interest trusts, used to provide both protection and tax efficiency.
Will Trusts For Protecting Inheritance – The Background
The testator is a single divorced client who owns:
- a property worth approximately £200,000; and
- savings and other assets worth approximately £272,000.
Her total estate is therefore around £472,000.
She has two adult children. Both are married.
She has two concerns:
- protecting the estate in the event that a partner moves into the property during her lifetime; and
- protecting the children’s inheritance against third party claims after her death, particularly in the event of divorce.
The Lifetime Position
Before turning to the Will, it is important to deal with the lifetime position.
Will planning cannot provide protection during the client’s lifetime against a new partner moving into the property. As a Will only takes effect on death, it would not prevent a partner from acquiring or asserting an interest in the property while the client is alive or from making any potential Inheritance (Provision for Family and Dependants) Act 1975 application following death.
Will Trusts For Protecting Inheritance – The Options
Moving onto the will, there are a few options on how the estate could be dealt with.
Outright Gifts
Leaving the estate outright to the children is the simplest option. It is easy to draft and easy to administer.
However, it provides very little protection from third parties. Once a child receives an inheritance outright, the assets belong to that child personally and may become exposed to a range of risks. These might include relationship breakdown, creditor claims, bankruptcy, business failure, tax issues, or pressure from others to use the inheritance in a particular way.
This highlights why we can use will trusts for protecting inheritance. A trust structure improves this position, as the child may not personally own the underlying capital.
Whole Estate to a Discretionary Trust
A discretionary trust is often the most protective approach.
The estate passes to trustees for a wide class of beneficiaries, typically including children, grandchildren, and remoter issue. No beneficiary has a fixed right to income or capital. The trustees retain full discretion over distributions.
This provides significant flexibility. The trustees can respond to circumstances at the time, rather than being bound by a fixed outcome.
This structure can be useful where a child is financially vulnerable, facing creditor pressure, involved in a relationship breakdown, at risk of bankruptcy, or where the family wishes to preserve wealth for future generations. The trustees may decide to delay distributions, make loans rather than outright gifts, or apply funds for a beneficiary’s benefit without transferring assets directly into that beneficiary’s personal ownership.
For example, if one child is experiencing financial difficulty when the client dies, the trustees may decide not to make an outright distribution at that stage. Instead, they may retain the assets in trust or make controlled advances when appropriate. This will provide stronger protection than an automatic inheritance under the Will.
In the context of divorce, this can be useful, although it should not be viewed as absolute protection. The family court has wide powers and may take trust interests, likely future resources, or patterns of benefit into account. However, assets retained within a trust are generally more protected than assets inherited outright by a child.
A discretionary trust will fall within the “relevant property regime” for inheritance tax purposes. This means the trust may be subject to inheritance tax charges on each ten-year anniversary and when capital leaves the trust.
The main complication is the residence nil rate band. This is only available where a qualifying residential interest passes to direct descendants. A discretionary trust will not qualify at the point of death.
However, this is not necessarily fatal. If trustees make an appointment within two years of death, section 144 Inheritance Tax Act 1984 will treat it as if it had been made by the Will for inheritance tax purposes. This may allow the residence nil-rate band to become available retrospectively if part or all of a qualifying residential interest is transferred to qualifying descendants within the time period.
This option offers strong protection, but it requires active trustee involvement after death.
Residence Nil Rate Band Life Interest
An alternative approach is to focus on tax efficiency.
The Will can provide for a life interest trust for the children over so much of the property as is needed to secure the residence nil-rate band. The balance of the estate would then pass outright to the children.
A life interest trust gives the beneficiary an entitlement to trust income.
For inheritance tax purposes, this type of trust will be an immediate post-death interest (IPDI). Where an IPDI applies, the life tenant(s) who are entitled to income are treated for inheritance tax purposes as owning the trust property. This means the trust assets are generally not subject to the relevant property regime while the IPDI continues, so ten-year anniversary charges and exit charges do not usually apply during that period. Instead, the value of the trust property will normally be taxed as part of the life tenant’s own estate on their death.
If structured correctly, it can ensure that the relevant share of the property qualifies for the residence nil-rate band. If children are life tenants, they are treated as inheriting.
In this case, the available RNRB would be £175,000 and the property is worth £200,000, only part of the property may fall within the available RNRB. If the trust was used in this circumstance, £175,000 of the property would pass to the trust, and remainder of the property and all other assets would pass to the children outright as part of residue.
This offers protection over the trust capital, but any assets passing outright remain exposed to the same risks discussed above.
Combined Structure
The Will can provide for:
- a life interest trust for the children over the share of the property required to utilise the RNRB; and
- a discretionary trust for the balance of the estate.
This would mean £175,000 of the property passing into the life interest trust, with the balance of the property and residue assets passing into the discretionary trust.
This would preserve the RNRB while also offering protection over the remaining estate. It also avoids the need for trustees to make a section 144 distribution within two years solely to secure the RNRB, as would be required if the whole estate passed to a discretionary trust.
The children would be entitled to income from the RNRB life interest trust. This could have issues should they be financially or personally vulnerable. However, if the trust is drafted flexibly with overriding powers and underlying discretionary provisions, the trustees may be able to restrict entitlement where necessary. This would result in the trust falling within the relevant property regime following death, but should not affect the initial availability of the RNRB.
This structure offers both tax efficiency and broader protection. The trade-off is increased complexity in both drafting and administration.
Will Trusts For Protecting Inheritance – The Role of a Letter of Wishes
Whichever trust structure is used, a separate letter of wishes to the trustees is essential.
Although not legally binding, it provides guidance to the trustees on how discretion should be exercised. It allows the client to set out their priorities in more practical terms.
Particularly if the client proceeded with the discretionary trust option, the letter of wishes should detail guidance for the trustees on exercising their discretion within two years to ensure RNRB can be available.
Conclusion
Will trusts can play a key role in protecting children’s inheritance where protection from third parties is a concern.
An outright gift is simple but offers little protection. A discretionary trust provides the greatest flexibility and control. A life interest trust can assist with preserving the residence nil-rate band. A combined structure can achieve both objectives, although with greater complexity.
The appropriate solution will depend on the client’s priorities; do they want matters simpler, or do they want to prioritise protection and IHT efficiency.
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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.
