Author: Helena Luckhurst
This article is taken from Helena Luckhurst’s blog The Wealth Lawyer UK
Parents, in particular, face a bewildering choice of structure options when it comes to making provision for their children in their Wills. Often the prospect of their child inheriting a large sum of money at age 18 does not appeal. Instead, being able to delay a child taking control of their inheritance until age 21 or 25, or later, or arranging for a series of staggered payments over the years is preferred. However, the tax consequences of the various options are not always explained and parents can end up making inappropriate choices.
In 2006, the Government of the day decided that parents should have to pay for the privilege of keeping assets tied up in trust beyond a child’s 18th birthday, by levying a capital tax on the child’s will trust in proportion to how long the child’s will trust lasts. Accordingly, parents who want to keep their child’s inheritance in trust until the child’s 25th birthday will find that the will trust pays more Inheritance Tax (IHT) than one that ends earlier, on the child’s 21st birthday. However, in an attempt to cheer up parents, a new form of will trust (the ‘age 18 – 25’ will trust), was introduced, with its ‘IHT lite’ charging regime, involving no IHT ten year anniversary charges and IHT exit charges of at most 4.2%, if a child’s inheritance was retained in the will trust until the child’s 25th birthday.
I often speak to parents who, having asked for a Will which ‘leaves assets to our children at age 25’, are completely unaware that delaying a child’s inheritance in this way will create a trust that needs to be administered after their deaths; and how that will trust will be treated for Income Tax, Capital Gains Tax and IHT purposes while the trust is in existence and when it comes to an end. Will income arising in the trust before the child’s 25th birthday be taxed at the child’s (often lower) rates or the trustees’ (often higher) rates? (It depends on how the will trust is worded.) Will Capital Gains Tax be triggered when capital distributions are made to the child – and can the gain be deferred by claiming hold over relief?
So what structuring choices do parents have when making provision for their children in their Wills? They can take their pick from any of the following:
(For more information on each type of will trust, see my briefing note ‘Making provision for minor children or grandchildren in your Will’.)
The problem faced by many Will advisers is that there simply isn’t the time to run through the various options in detail. In some respects, it is also a futile exercise because at the time the parents make their Wills the children can be very young – who knows how they will turn out? That’s why, for many parents, opting for a discretionary will trust for their children is a good compromise. Although discretionary trusts are subject to the full force of the IHT periodic charges regime (of ten year anniversary and exit charges) from the parents’ death, the will trustees can choose to convert the discretionary trust into a BMT, age 18 – 25 or an IPDI at any time before the second anniversary of the parent’s death and for IHT purposes, it will be as though the trust had been a trust of that character all along. As long as there are some trusted trustees on board, it’s an ideal way for parents to get on with the important task of making Wills to protect their family, even if no one knows how the little ones will turn out.
Helena Luckhurst, Partner, Fladgate LLP (firstname.lastname@example.org)