In the Money section of Saturday’s Telegraph, an article shouted “Inheritance tax trap: more than 100,000 families won’t get the new tax break”! A little bit of scaremongering perhaps, but enough to wonder if you are one of those 100,000 families? Those who read on will know that the article refers to the new Residential Nil Rate Band (RNRB) which is being introduced from 6 April 2017 and specifically, the implications of having provisions for a discretionary trust within your will, something that is more common than perhaps you might think.
To recap, the RNRB is being gradually introduced from 6 April 2017 to provide additional relief for those passing the family home to their children on death. By the time of its full implementation in the 2020/2021 tax year, it will mean that up to £1 million of a couple’s estate (up to an estate value of £2 million) will be exempt from inheritance tax (IHT). So what’s the deal with discretionary trusts? As the article states, the new RNRB only applies where the individual’s direct descendants inherit the home, or a share of it. The trouble with a discretionary trust is that in accordance with Trust Law, it is the Trustees and not the beneficiaries who own the trust assets. This means that should the family home inadvertently be settled into such a trust on death, the child cannot be said to have been inherited it, even if they are a beneficiary of that trust. If it is not “inherited”, no RNRB is applied and additional tax of up to £140,000 could be due.
However, the position is not as doom and gloom as it perhaps appears. Historically, discretionary trusts were widely used to protect the regular nil rate band (NRB) of the first spouse to pass away before a change to the law nearly ten years ago, to permit the transfer of the unused NRB (currently £325,000) to the surviving spouse. Wills that have not yet been updated to reflect this change are indeed in need of fast amendment as they are the most at risk of the “trap”. Ignoring those for the time being though, the main reasons that discretionary trusts continue to be included within wills are for family asset protection and/or the protection of the vulnerable or minors, in a way that cannot be achieved if an estate is passed directly to descendants (no matter how lengthy your Letter of Wishes may be). It is therefore important to note, that the RNRB will continue to apply to Trusts for Bereaved Minors, 18 -25 Trusts, Trusts for Disabled Persons and Interest in Possession Trusts. As such it is possible, with perhaps slight tweaking, to continue the purpose of a discretionary trust within a will, without having to scrap the important protections that it offers.
It is also important to pay attention to the £2 million limit on estate value. Where the value of an estate exceeds £2 million, the RNRB is reduced by £1 for every £2 above this amount until the RNRB is effectively dis-applied. Given crazy house-prices in the South East and the fact that the £2 million valuation is calculated after liabilities but before reliefs such as Business Property Relief, many estates could exceed the £2 million limit without much complexity in their affairs. Where this is the case, a discretionary trust many still be handy. For instance, looking at a couple’s estate as a whole, by transferring an amount up to the NRB into a discretionary trust on the first death, you effectively reduce the value of the second estate, such that the £2 million threshold might not be exceeded and the RNRB can be applied (as it might not have been had the whole estate been transferred to the surviving spouse). Each estate should be considered on a case by case basis without paying any attention to sweeping statements! A discretionary trust, in certain circumstance, could indeed remain “tickety boo”.
This is a good point in time for everyone with a discretionary trust written into their will, to dust it down and consider updating it. As explained, it is not the case that the relevant clause should merely be struck out and it be the death of the Discretionary Will Trust. The purpose of a discretionary trust still has its place in protecting your estate and your descendants and with our assistance, we can help you ensure that is not lost.