Author: Helena Luckhurst
This note offers guidance for anyone who wants to leave assets to minor children or grandchildren in their Will.
You may be content for minors to inherit relatively small amounts of money outright after your death, perhaps regardless of what age they have reached at your death. However, you may not want a minor to inherit more substantial sums at age 18 or younger. This note provides a brief summary of your options for making provision for minors and the tax consequences of each.
Minors to inherit at age 18 (or younger)
Option 1: Bare trust for minor
In a bare trust situation, the only issue preventing the minor from taking their inheritance at your death is their minority. At 18, the minor would be able to call for their inheritance. In addition, the inheritance would belong to the minor in all senses from your death. Accordingly, if the minor died or faced claims against their assets, the inheritance would be the minor’s asset and (absent any non-UK connections) pass under the English intestacy rules. It would also form part of their estate for Inheritance Tax (IHT) purposes. Income or capital of the inheritance could be applied for the minor’s benefit at any time before the 18th birthday. Any income or gains generated by the inheritance between your death and their 18th birthday would be income or gains taxable on the minor (and a tax return may need to be completed for them) but often minors pay relatively low rates of tax as their other income and gains are limited, especially if their Income Tax personal allowance and Capital Gains Tax (CGT) annual exemption are fully available. The transfer of the inheritance into the minor’s name at age 18 would not trigger IHT or CGT.
Option 2: Bereaved Minors Trust (BMT) (for parents only – not available to grandparents)
A BMT can be created following a parent’s death, by the terms of their Will or on intestacy (in the absence of a Will). The child must become entitled to the capital of their inheritance at age 18 but it can be paid out for the child’s benefit before their 18th. The BMT trustees usually have discretion over whether to pay out the trust income or not but income can only be applied for that child’s benefit. Any income that the trustees retain will be subject to higher trust Income Tax rates and accumulated income will pass to the child at age 18. The inheritance does not belong to the child until their 18th birthday, so cannot be subject to claims against the child. The terms of the BMT usually govern what happens to the inheritance in the event that that child dies under 18 – it is not governed by the intestacy rules.
A well drawn BMT will include a power to advance capital on trust for the child beyond their 18th birthday. This could come in very useful if the child is not as financially mature at age 18 as the parent hoped for! However, the BMT trustees would have to ensure that retaining the child’s inheritance in trust was demonstrably for that child’s benefit. This cannot be guaranteed and can lead to dispute.
There are no IHT charges applicable to a BMT, unlike other options (see below) and any gains triggered by the ending of the trust on the child’s 18th birthday can be deferred (hold over relief).
Minors to inherit no later than age 25
Option 3: Age 18 – 25 trust (for parents only – not available to grandparents)
This type of trust can only be created by a parent making a Will containing a trust. The trust must provide that, on or before their 25th birthday, a child takes the capital of their inheritance outright. Income can either be paid to the child as it arises from a certain age (perhaps 18) (the child’s personal allowance and tax rates apply from that point onwards) or be paid to, or for the benefit of, the child, at the trustees’ discretion, at any age before 25 (higher trust Income Tax rates apply but the child may be able to reclaim some Income Tax following distribution). The income must be applied for the child’s benefit or accumulated and distributed to the child at the age of 25 at the latest.
Any capital distributions to a child will trigger CGT but, if the trustees transfer over the inheritance in the form of the assets themselves (i.e. they do not liquidate the inheritance first) the gain can be deferred until such time as the child chooses to liquidate the assets.
Usually if will trust income is not payable to a beneficiary as it arises (i.e. it is payable at the trustees’ discretion instead), the trust is subject to periodic IHT charges throughout the lifetime of the will trust. Age 18 – 25 trusts are given favourable treatment because only a scaled down version of the IHT regime applies to them, which means that if capital is retained in trust until the child’s 25th birthday, the IHT charge payable when the inheritance leaves the trust is at most 4.2% of its value at that time. If distributions are made after the child’s 18th but before age 25, the percentage charge reduces. Distributions of capital before age 18 are IHT free. The will trustees have discretion to distribute capital from the trust to or for the child’s benefit at any time before age 25, so can control the level of IHT charge, which is usually held in balance with the level of financial maturity demonstrated by the child and the parent’s wishes.
No set age for minors to inherit
Option 4: an Immediate Post Death Interest (IPDI)
Parents and grandparents who do not want to have any periodic IHT charges applying to the minor’s inheritance while it is in trust can opt for an IPDI instead. From the start, the IPDI must give the child the right to the income of their inheritance as it arises (no matter what their age) and therefore the income will be taxed as the child’s. The terms of the IPDI can provide for it to end at a set date but if preferred, to retain flexibility, the IPDI trustees could be given a power to distribute the capital of the inheritance to the child at any age. The parent or grandparent can record at what age they would consider a transfer to be appropriate (or stagger transfers at different ages) but the matter remains at the discretion of the trustees. Thus a careful choice of IPDI trustees is crucial but the flexibility can prove very helpful if the minor lacks financial maturity.
The quid pro quo for no periodic IHT charges for the IPDI is that the IPDI assets will form part of the minor’s estate for IHT purposes and will be taxed accordingly in the event of the minor’s death at any age, although for most minors this will be statistically unlikely to occur. The risk could be covered by insurance at the time if desired.
Unfortunately the transfer of assets out of the IPDI to the minor is deemed a disposal for CGT purposes for which the gain usually cannot be deferred. CGT will be payable at the trustees’ 28% rate.
Option 5: a discretionary trust
Parents and grandparents preferring to keep their options completely open can provide in their Wills for a minor’s inheritance to pass into a discretionary trust after their death. The trust can last for up to 125 years but usually the discretionary will trustees will be guided by written advice provided by the parent or grandparent during their lifetime as to when income and capital distributions should be made to a child. There is no set age at which the minor takes income or capital, which can be applied to or for the minor’s benefit both pre- and post-minority.
Discretionary trusts are subject to the full periodic IHT regime for trusts, involving ten year anniversary charges on each decennial anniversary following death (if the trust is still in existence at that point) and exit charges on capital distributions. However, discretionary trusts offer full flexibility. If the class of beneficiaries is widely drawn, inheritances can be reallocated between family members if the needs of different family members fluctuate or are hard to anticipate. Discretionary trusts offer inter-generational IHT planning possibilities because they allow family wealth to pass down the family tree (or sideways, to siblings etc.) without the 40% IHT charge that can apply when a family member passes their personally held wealth on to another family member on death.
Gains realises on capital distributions from discretionary trusts can be deferred until the beneficiary liquidates the asset.
Please let us know if any minors in your family are disabled in any way as special types of will trust may be available
Another way: keep your options open
Often it’s impossible to know the best option to go for at the time you make your Will. Children and grandchildren change as they grow up and they could be older or younger than anticipated, in all senses of the words, by the time of your death.
Fortunately you can delay the decision until after your death. If we include a discretionary trust in your Will with a power to appoint capital onto different trusts, the trustees of the discretionary trust have up to two years after your death to turn it into any of the options mentioned above. The IHT and CGT consequences will be the same as if your Will had included that option in the first place. This is often the ideal solution, as long as you trust your will trustees to make the right decision when the time comes. Your choice of will trustees is crucial, therefore.
This note is not an exhaustive review of all the taxes applicable to will trusts for minors but is designed to raise awareness of the different options available. We recommend that you discuss your specific requirements with your usual contact at Fladgate, who will help you choose the right option for your family.
At a glance summary table of capital taxes for will trusts for minors.
|Inheritance Tax||Capital Gains Tax|
|Minor’s estate||Trust periodic charges||Distribution||Trustee disposal|
|Bare Trust||Belongs to minor’s estate||N/A||No||Minor’s CGT rate applies|
|BMT||Belongs to minor’s estate after 18||N/A||Yes; hold over relief available||Trust CGT rates (unless trustees make vulnerable persons trust election)|
|Age 18 – 25||Belongs to minor’s estate after 25 at the latest||No ten year anniversary charges. Max 4.2% exit charge at age 25. No exit charges prior to 18th birthday||Yes; hold over relief available||Trust CGT rates|
|IPDI||Belongs to minor’s estate||N/A||Yes; no hold over relief available||Trust CGT rates|
|Discretionary Trust||N/A||Ten year anniversary and exit charges||Yes; hold over relief available||Trust CGT rates|
Helena Luckhurst, Partner, Fladgate LLP (email@example.com)