- A will incorporating a fully discretionary will trust can be a good solution for a client going through a divorce
- Alternatively, where inheritance tax is an issue, a client could utilise the spouse exemption in the event of a death before the decree absolute is obtained
- Trusts can offer flexibility, protection and opportunities for inheritance tax planning
As an associate in the private tax team at Mills & Reeve, I often assist my colleagues in our matrimonial team with a range of queries from the taxation implications of financial settlement provisions to the most appropriate type of will for a divorcing client.
On the day in question, my colleague Helen Bowns, asks me to give her client Anthony Jones a call as Helen is advising him in respect of his divorce and he wants to change his will to ensure that none of his estate passes to his wife, Mary.
Speaking to Anthony reveals that his sole net worth is in the region of £750,000 and also that he is the joint owner of a property with Mary, worth in the region of £500,000. Mary is wealthy in her own right. Anthony’s main priorities are to provide for his children, Sophie and James, in the most tax efficient way to ensure that the funds are available for their long term benefit.
Anthony explains that Sophie is 28, is married and has a young daughter. James is 21 and still at university, with no relationship to date lasting beyond a couple of months.
My advice to Anthony is that rather than directing that his estate passes directly to Sophie and James that he considers directing it into a discretionary trust, under the terms of his will, for their benefit. The major advantages of this arrangement being:
- Funds passing into the trust will be kept outside of his children’s estates for inheritance tax purposes. Anthony explains that they were already relatively wealthy in their own right following gifts from their mother. This potentially avoids a 40 per cent inheritance tax liability on the death of Sophie or James.
- The funds would be ring-fenced from attack in the event of Sophie divorcing in the future. Anthony explains that her relationship is strained although he is hoping that this is simply as a result of the pressures of bringing up a young child! He certainly does not want to benefit Sophie’s husband in the event of a future divorce, even though he gets on well with him at the moment.
- Controlling the management of the funds. Anthony explains that neither of his children are good with money and he is fearful, especially in James’s case, that he will fritter away his inheritance. He therefore decides to appoint his brother (who is a chartered accountant) as a trustee, together with Sophie and James.
- To provide flexibility in the future. If Sophie did not require use of these funds moving forwards Anthony wants her children (his grandchildren) to benefit from her share. This would keep the funds outside of her estate for tax purposes and would allow Sophie to undertake more inheritance tax planning of her own in the future, with the comfort of knowing that she still had access to her share of the funds held in this trust. The same would be true for James, if he also had children in the future.
I advise that Anthony should sever the joint tenancy of the property he owns with Mary so that they each co-own as tenants in common. This would mean their respective share of the property would pass under the terms of their wills (and in Anthony’s case into the discretionary trust) on death, rather than directly to the survivor. This is important as he does not want Mary to receive the benefit of his share of this property.
Using this structure, Anthony’s estate will be liable to inheritance tax of around £270,000, assuming he has his full nil rate band (currently £325,000) available.
This type of will trust is also suitable in other circumstances, as follows:
- Unmarried couples should consider structuring their wills so that on the first death his/her estate passes into a discretionary trust. This will have all the advantages set out above and most importantly will ensure that inheritance tax is not suffered on the estate of the first to die and then again on the same property on the second death.
- Both married and unmarried couples consider directing their estate into a discretionary trust on the second death. Again, it offers the advantages set out above and will allow the trustees the necessary flexibility to react to circumstances that exist at the time (ie, an unexpected divorce).
If the relationship between Anthony and Mary Jones has not broken down completely, despite the fact they were divorcing, and both shared the same objective of providing for their children, I may have recommended a slightly different will structure for Anthony. The alternative is that he could direct that his estate passes into a flexible life interest trust in favour of Mary (if she survives him and prior to formalising their divorce – obtaining a decree absolute). Spouse exemption for inheritance tax purposes would still be available (as they would still be legally married) to ensure that there would be no inheritance tax charge on Anthony’s death. The funds could then, straight after his death, be moved on for the benefit of his children. In other words we would be using the trust as a “conduit” to move assets on for the children’s benefit.
In these circumstances, if Mary survives seven years from the date the funds were moved on, there would be no inheritance tax charge whatsoever.
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