Do you trust your Will to save inheritance tax?

Discretionary trusts, popular in Wills between spouses a decade ago and designed to save inheritance tax (IHT), could end up causing bigger tax bills when new rules come into force next year.

April 2017 sees the phased introduction of an ‘additional’ IHT allowance, applicable when a home is passed on death to children or grandchildren.

The current position is that IHT is charged at 40% on estates worth more than £325,000 or on estates worth more than £650,000 for spouses and civil partners. This is subject to other potential factors like the impact of gifts made in the seven years before death.

By the 2020/21 financial year, the maximum IHT-free amount will be £1million for qualifying spouses and civil partners who leave their home to their children.

However, if you have a discretionary trust in your Will, the additional IHT allowance may not apply in certain circumstances.

Discretionary trusts were commonplace in Wills between spouses before 2007 as a way of each person utilising their individual IHT exemption. Typically, when the first person dies, a half share of the house passes into a trust as a way of using up that person’s exemption, while allowing the survivor to have use of the property.

A key characteristic of a discretionary trust is that there is no one beneficiary entitled to the trust’s assets, rather there is a pool of potential beneficiaries that the trustees exercise their discretion in benefitting.

A requirement of the additional IHT allowance is that the children must inherit the property outright, rather than at the discretion of trustees. However the rules are not straightforward. It may not present a problem but executors and trustees dealing with an estate comprising a discretionary trust or couples with Wills containing them should review their position.