Discretionary Will
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How to use a Discretionary Trust Will to pay less Inheritance Tax in the UK
Typically, most married couples who make Wills leave everything to each other. That’s understandable, but it’s not always the best thing to do, and it could mean that the family loses out financially because of Inheritance Tax.
If your estate (your savings, house, possessions, any insurance policy payouts, etc) is worth over £285,000, then Inheritance Tax is charged at the rate of 40% on any amount above this figure.
If £285,000 sounds a lot to you, think again. Many people have considerable assets, especially if they own their home. A large number of married couples now have a joint estate worth well in excess of the current Inheritance Tax threshold (IHT) of £285,000.
If a husband and wife have made Wills leaving their estates to each other, there’s no tax payable on their estate when the first one dies. Potentially, a tax liability arises when the second partner dies. Without proper planning, a large inheritance tax bill can be incurred when the estate is finally passed on to the children. This means that your family and loved ones could lose a sizeable part of their inheritance – swallowed up by the taxman.
Typically, for many couples, the situation works out like this . . .
Mr & Mrs Green have an estate - including home, cash, investments, insurance payouts, etc, worth £570,000. They wish to give everything to the survivor when the first one dies, and on the second death, they wish everything to go to their children. Mr Green dies first and leaves everything to his wife. There is no tax payable on his death, because gifts between spouses are exempt (the rules are exactly the same whoever dies first). However, the problem arises when Mrs Green dies.
Tax is payable on Mrs Green’s death as follows:
Mr Green’s assets of £285,000 pass to Mrs Green on his death. On Mrs Green’s death, all her assets (less tax) pass to Mr & Mrs Green’s children. Tax is payable at 40% on amounts over £285,000, therefore Mrs Green’s estate will incur a tax charge of £114,000. This means that Mr & Mrs Green’s children will only receive £456,000, instead of £570,000 as the Tax Man has taken a big slice of the couple’s estate.
By giving everything to his wife in his Will, Mr Green wasted his tax-free allowance of £285,000, and more tax was paid than was necessary.
Inheritance tax could be avoided by passing assets directly onto the children on Mr Greens death as according to UK law, Mr & Mrs Green each own 50% of their joint estate. This way Mr Green’s tax free allowance would be used but there is, of course, an obvious problem with doing things this way. Carrying out the provisions of the Will - giving Mr Green’s share of the estate to their children – could leave Mrs Green short of money. She may even have to sell the marital home, and her standard of living could suffer badly. She would also have no control over the money held by the children.
A better way of avoiding Inheritance Tax according to [Seeing Red] the financial and legal services specialists is to advantage of a special tax saving technique called a Nil Rate Band Discretionary Trusts.
By incorporating a Nil Rate Band Discretionary Trust into his Will, Mr Green can enable Mrs Green to continue to benefit from their estate, while minimising - or even eliminating - inheritance tax. Essentially, this involves setting up a trust, which makes a loan to Mrs Green.
Discretionary Trust Wills work by making use of the Nil-Rate band (£285,000) of both spouses, rather than just that of the surviving spouse (as would normally be the case).
It works like this...
Assuming that the total value of their estate - including home, cash, and investments - is £570,000. In his Will, Mr Green puts his share of the estate (£285,000) into a trust which takes effect on Mr Green’s death. A loan of £285,000 is made to Mrs Green from the trust, in return for an I.O.U. from her; there is no interest on the loan, which will be paid off on her death. On Mr Green’s death, Mrs Green’s estate equals £285,000. However, she will also have access (via the loan) to the trust monies (Mr Green’s estate) - a further £285,000. Giving her a total of £570,000.
On Mrs Green’s death, her assets pass to her children and the loan is repaid out of her estate. Therefore, the total value of Mrs Green’s estate was £570,000. Less the I.O.U. of £285,000 from Mr Green’s Trust, leaving Mrs Green with a net estate of £285,000, which is at the Inheritance Tax threshold, therefore no tax is due. The children, therefore, get £285,000 from Mr Green’s Trust plus £285,000 from Mrs Green’s estate. Because both these sums are just at the Inheritance Tax threshold, there is no tax to pay. The children receive a total of £570,000 and the taxman receives nothing. Which means less money for schools, hospitals and old-folks homes, equipment for our soldiers, and so on.
Using a Nil Rate Band Discretionary Trust has:
• Enabled the Green family to save over £114,000 in inheritance tax • Given Mrs Green control over the assets of the marriage after the death of her husband • Enabled her to maintain her lifestyle (without having to sell major assets such as her home) • Maximised the amount of family wealth passed on to future generations.
Setting up a Discretionary Trust Will takes a little more time and costs slightly more than an average Will, but for most people the advantages are overwhelming. There’s a lot to think about, this is just a simple guide and you really need to take professional advice.
