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Discretionary Will Trusts, Inheritance Tax Liability and Trust Funds

Most married couples that are presented with an Inheritance Tax liability, disregard the opportunity offered to them by the death of the first spouse (as there is no Inheritance Tax between married couples the liability only manifests itself when the second spouse dies).

Typically, the first spouse to die leaves their estate to the surviving spouse thus compounding the size of the survivor’s estate. When the surviving spouse dies, their beneficiaries face an Inheritance Tax bill based on the size of the combined estate.

The reason why most married couples fail to take advantage of the opportunity presented to them by the death of the first spouse (in terms of reducing the size of the survivor’s estate) is that most married couples do not want to leave their estate, or part of it, to beneficiaries other than their surviving spouse, only to find that the surviving spouse then ‘runs out’ of funds.

This is perfectly understandable but there is a third option. A Discretionary Will Trust, this allows for the creation of a Trust Fund (up to the then current personal Inheritance Tax allowance) on the death of the first spouse. The balance of the first spouse’s estate (in excess of the personal Inheritance Tax allowance) still passes to the surviving spouse, free of Inheritance Tax. The surviving spouse would be appointed as the Dominant Trustee (with power to ‘hire and fire’ other Trustees) and would be named as one of the Discretionary beneficiaries of the Trust Fund (together with children and/or other beneficiaries).

If the surviving spouse needs funds, then they can be ‘borrowed’ from the Trust Fund thus creating a debt on the surviving spouse’s estate. When the surviving spouse dies the debt to the Trust Fund is repaid, which in turn reduces the size of the surviving spouse’s estate. In this way, full advantage will always be taken of the Inheritance Tax allowance associated with the death of the first spouse.

When the surviving spouse dies, their beneficiaries will receive the surviving spouse’s estate plus the Trust Fund (as they are the Trust Fund’s remaining beneficiaries). Using this method, married couples are able to make use of two personal Inheritance Tax allowances (one for each spouse) and thus pass more of their estate to their beneficiaries. Consequently, the current potential Inheritance Tax saving is 40% of 275,000 or £110,000.

Note: In the absence of sufficient assets held in single names, Severance of Tenancy is a means of making additional funds available in order to make full use of the capacity (the then current personal Inheritance Tax allowance) of the Trust Fund.