With significant inheritance tax benefits for gifts between spouses or civil partners, it makes financial sense for married couples to leave everything to each other on death.
However, with the increase in second marriages and step-families, you could experience real tension between wanting to provide for your partner after their death and ensuring that you do not inadvertently disinherit their your children.
Outright Gift or a Trust?
Many people leave part or all of their estate to their spouse outright. This is certainly the simplest approach. But for many it may be more appropriate to leave your estate on trust for your surviving spouse.
Before looking at the reasons for using a trust, it is worth considering how a trust works.
If, for example, a married man leaves his estate on trust for his wife, the trust would provide her with income (and potentially also capital if the trustees choose to pay it to her) for the rest of her life.
The trust would be very flexible and other people could potentially benefit including the husband’s children and grandchildren and their spouses and civil partners. However, the wife would be entitled to receive all of the income from her husband’s trust unless the trustees decide otherwise.
The husband would create the trust, and appoint the trustees, in his will. He could give the trustees guidance in a letter of wishes covering how he would like his estate to be dealt with, after his death. The trustees would be expected to follow the husband’s wishes unless there were good reasons not to.
Reasons for using a trust
1. Protecting the husband’s children
The husband could specify that on his wife’s death the trust assets will pass to his children (or other chosen heirs), rather than to his wife’s family or any future partner she may have.
This is particularly important where second marriages and step-children are involved.
2. Tax efficiency and onward gifts
In terms of gifts from the trust during the wife’s lifetime, huge amounts of inheritance tax can potentially be saved by the trustees passing trust assets down to the husband’s children or grandchildren during the wife’s lifetime.
The assets would avoid inheritance tax provided the wife survived the transfer by seven years.
If the husband left his estate to his wife outright, he would be reliant on her to make such gifts herself. As a widow, she may be unwilling to do so. With a trust the husband can safely rely on the trustees to make the gifts after his death.
When making gifts by the trustees rather than by the wife, if the husband leaves his estate to his wife on trust, the trustees could still make tax efficient onward gifts to the husband’s children or grandchildren even if the wife was not capable of making decisions herself.
This would not be the case with an outright gift.
3. Protecting the husband’s assets
With a trust over the husband’s estate, the wife would not actually own the underlying capital for the purposes of means-tested benefits. This may offer protection against having to pay care home fees.
A trust would also provide protection against other family members (for example, the children) putting pressure on his wife to give them assets from his estate after his death. This is because the trustees may find it easier than the wife to refuse any inappropriate requests.
A trust will also protect against the possibility of the wife’s own profligacy after her husband’s death.
4. Making life easier for the wife
By leaving his estate on trust for his wife, the husband will relieve her of the burden of having to manage the investment of the assets, passing this responsibility to the trustees instead.
5. Avoiding tax on a sale of the husband’s home after his death
If the husband leaves his estate to his wife on trust, there could be valuable capital gains tax savings if the estate contains a second home or rental property.
6. Practical financial help on the wife’s death
On his wife’s death, the husband’s trust would continue to exist and money could immediately be paid out to the children or grandchildren from the trust. Money from this trust could be used to pay expenses and inheritance tax on the wife’s death.
Reasons for not using a trust
1. Potential claim by the wife under the Inheritance (Provision for Family and Dependants) Act 1975
The wife could have a potential claim against her husband’s estate under the 1975 Act on the grounds that she has not received reasonable financial provision on his death because she is only entitled to the trust income and not the capital.
Whether the wife would actually bring a claim in practice will depend on many factors including the particular family dynamics but where second marriages and step-children are involved, the risk is greater.
2. Complexity
An outright gift by the husband of his estate to his wife in his will would be simpler than creating a trust, as it would remove the time and expense involved with an ongoing trust after his death. With a trust, the wife may also resent not having sole control of her husband’s estate after his death.
This article has been provided by Andrew Goldstone, head of personal tax and estate planning and Victoria Turner, assistant, at Mishcon de Reya Solicitors. They can be contacted on 0207 440 7000.
This article first appeared in Financial Planner trade journal in 2009.
Key Considerations:
As Andrew and Victoria have pinpointed, it’s really important that you think through how you want your affairs to be managed after you’ve died. What do you want to happen? Have you discussed the issues with your loved ones?
Action Point
Regardless of how old you are, take the time to consider how you’d like your estate to be distributed. And if avoiding inheritance tax is an issue for you, research your options and above all, make sure you get expert advice (which is especially important when trusts are involved).
