What is a Discretionary Trust of Residue within the Will?
A common definition for a Trust is that it is a legal obligation where one or more Trustees are legally responsible for managing the Trust assets on behalf of the beneficiaries. Best advice would be to have at least 2 Trustees as this is the minimum required to deal with Land Titles.
A Discretionary Trust gives the Trustees the full discretion as to who, how and when any Potential Beneficiaries of the Discretionary Trust are to benefit. A Beneficiary of a Discretionary Trust has no legal right to the capital or the income of the Trust and so clearly it is vital that the appointed Trustees understand the role and the legal responsibilities it holds. A spouse/ partner, children, their issue and remoter issue are very often referenced as the Potential Beneficiaries.
The use of this Trust can be a significant consideration if your clients wish to provide the maximum protection for their estate, following their death, from a range of possible threats to their beneficiaries. Notably: Care Costs, Divorce, Marriage after Death, Multi-generational IHT, Creditor Claims or Bankruptcy.
The legal owners of the deceased’s assets are the Trustees and not the beneficiaries, although a beneficiary could be a Trustee as well. (A Trustee has to be over the age of 18, have capacity and not be bankrupt).
A Discretionary Trust of Residue within the Will is a Trust that would be established on death by the Will. The residue of a client’s estate will be the whole remaining estate following the payment of any debts of the deceased and any legacies.
When to consider using the discretionary Trust of Residue within the Will
When considering the use of the Discretionary Trust of Residue within the Will, it would be important to be mindful as to the value of the client's ‘residue’ estate.
If the ‘residue’ is in excess of the client's available Nil Rate Band and is settled into the Discretionary Trust on death, then Inheritance Tax would be due. If there is a surviving spouse then this would be unnecessary and a different structure of Trusts would be recommended. (A Discretionary Trust for the NRB and the Interest in Possession Trust for the residue).
Furthermore on each 10th anniversary of the Discretionary Trust (i.e. each 10th anniversary of the date of death), were assets within the Trust still to exceed that days NRB then further (Periodic) Charges would apply. The Trust will have a ‘lifespan’ (known as the Perpetuity Period) of 125 years from the date it is established.
Whilst the Discretionary Trust of Residue within the Will can be utilised by any client (married or otherwise) with any wealth, it would be most appropriately considered if it is known that a client’s residue estate value is anticipated to be less than the Nil Rate Band value at the date of death.
Flexible Interest in Possession Trusts
The Interest in Possession Trust of Residue within the Will has similar traits to that of the Discretionary Trust. That is, it is created by the Will on death, it would have a 125 year Perpetuity Period and can provide maximum protection of the deceased’s residue from Beneficiary's remarriage, Divorce, Creditor Claims and in some cases Inheritance Tax.
Unlike the Discretionary Trust this type of Trust includes a type of Beneficiary, known as an ‘income Beneficiary’. The ‘income beneficiary’ has a current legal right to the income from the Trust as it arises. Critically HMRC then deem the capital value of the Trust to be in the ‘income beneficiary’s’ estate for the calculation of their IHT on their death.
However the Interest in Possession Trust doesn’t get taxed ‘periodically’.
If the ‘income beneficiary’ selected is a spouse / civil partner then on first death there would not be Inheritance Tax due. HMRC accept that it is a ‘gift’ for which gains spousal exemption.
There will also be further Potential Beneficiaries, much the same as a Discretionary Trust which very often will include children, grandchildren and future issue. It’s not uncommon that the spouse/ civil partner would also be reflected as such too. Such Beneficiaries can benefit from the capital as per the Trustees' decision.
When to consider using the Interest in Possession Trust of Residue within the Will
Invariably it would be a consideration when an individual’s estate exceeds the NRB value.
It would be commonly considered to be utilised by married / civil partner couples who have an estate in excess of the 2 NRB’s. If the spouse / Civil partner is the Income Beneficiary then there would be no IHT due on first death, although this could be still due on second death. There would be no Periodic Charges applied to the Trust either.
Do note that if the whole estate of a married/ civil partner individual (minus debts and specific legacies), is directed to the Interest in Possession Trust then in some cases very little, if any of the deceased’s Nil Rate Band would have been utilised. When the surviving spouse then passes away it would be down to their Executors to claim any usused transfer of Nil Rate Band, assuming the legislation still exists. Were it to be considered to utilise the NRB in the Will on first death, then a Nil Rate Band Discretionary Trust within the Will could be utilised with the Interest in Possession Trust of Residue used to cater for the residue.
The Interest in Possession Trust of Residue could technically be used by single persons too but it is important to note that if the individual does have an estate in excess of the NRB, IHT would of course be still due on their death (unless otherwise planned for). Furthermore the amount then settled to the Interest in Possession Trust of Residue will also be in the estate of the chosen ‘income beneficiary’ for their IHT. To at least avoid the net estate impacting on a chosen Income Beneficiary it would invariably be wiser to consider utilising the Discretionary Trust of Residue within the Will.