If you’ve ever seen a film with people hiking in America you’ll often see signs or advice being given to watch out for bears. Neil Macleod, Senior Technical Manager at M&G says that this always makes him think about trusts created on death and in particular, Will trusts.
Working with trustees of a Will trust is one of those areas where advisers can add huge value but it’s also where things can quietly go wrong.
And interestingly, it’s rarely about picking the “wrong” investment. More often, the problems come from not quite understanding what the trust actually is, how it works, and how its taxed.
One of the biggest (and most common) issues is surprisingly simple: not reading the Will properly. It sounds obvious, but sometimes advisers rely on a summary, a client explanation, or a few headline points rather than sitting down and working through the actual wording.
The trouble is, small drafting differences in a Will can completely change how a trust operates. Things like powers of advancement, accumulation clauses, or conditions around age can have a major impact on what trustees can, and can’t, do.
If you don’t fully understand the Will, you’re potentially building advice on shaky ground from the start.
But perhaps the most fundamental mistake is misidentifying the type of trust that’s been created. It’s surprisingly easy to get this wrong. A trust might “feel” discretionary because there’s some uncertainty around outcomes, or it might look like a bare trust because there’s a named individual involved.
But unless you properly analyse the terms, you can end up applying the wrong tax treatment.
A good example of this is where the Will leaves a legacy for a minor and it’s assumed that a bare trust has been created. It might be bare but its a dangerous assumption to make.
In a true bare trust, the beneficiary has an absolute right to both income and capital. But you won’t always see the words “bare trust” written down.
You may come across something in a Will leaves a legacy to grandchildren which states:
“for such of my grandchildren as shall survive me and in equal shares absolutely”
In the absence of any other conditions, this wording would create a bare trust. The only condition for the beneficiaries interest to vest is to be alive at the time of the testator’s death.
Where it gets trickier is when there are conditions attached as subtle differences in wording can make a significant difference. Take the following example.
“for such of my grandchildren as shall survive me and attain the age of 18 years”
In this example the beneficiaries interest doesn’t vest absolutely simply by surviving the testator. They also need to attain age 18 before they become absolutely entitled so this is not a bare trust.
It’s important to establish whether a trust is truly bare or not as this makes a significant difference to the tax treatment of the trust.
There are also specific types of trust that come into play for younger beneficiaries. These are not always easy to spot as they will not be explicitly referred to in a Will. They are defined by law and will exist where certain conditions are met.
Trusts for bereaved minors
The definition of a “trust for a bereaved minor” is outlined under S71A of the IHT Act 1984. In order to qualify certain conditions must be met. Broadly speaking in the context of trusts arising on death, these are:
- The trust must be established under the Will or intestacy, of a deceased parent (or step-parent) of the child
- The bereaved minor must become absolutely entitled to the settled property and any income arising from by the age of 18.
The term “bereaved minor” means a person who has not yet attained the age of 18, and at least one of whose parents has died
A trust for a bereaved minor is a special type of discretionary trust so income and gains are taxed at trustee rates rather than on the beneficiary.
This can result in high tax rates however, it’s possible to mitigate this. A bereaved minor qualifies as a “vulnerable beneficiary” so the trustees can complete a “vulnerable person election form“ (form VPE1).
If the election is made, trustees get a deduction from their income tax or capital gains tax liability to that which the beneficiary would have paid if the income or gains were being assessed on them.
Although technically a discretionary trust, qualifying bereaved minor’s trust are exempt from the IHT periodic or exit charges normally associated with discretionary trusts.
Another trust that you might come across is the “18-25 trust”.
18-25 Trust
IHT Act 1984 s71D explains that an 18-25 trust can be created by the Will of a deceased parent (or step parent) of the beneficiary.
The beneficiary must be under age 25 and they must become absolutely entitled to the trust capital and income by the age of 25 (if a trust qualifies as a trust for a bereaved minor then it cannot be an 18-25 trust).
Again this is a discretionary trust so care needs to be taken when considering the impact of tax on investments.
Although discretionary, an 18-25 trust receives special IHT treatment which means periodic and exit charges only apply for the period between the beneficiary reaching age 18 and becoming absolutely entitled to the trust property.
The key point is to make sure you know what you’re advising on before you make an investment recommendation.
Read the Will properly, identify who the beneficiaries are (and what rights they actually have), and understand what type of trust you’re dealing with. If you do come across a trust you think is Bare, remember the hikers and don’t make any sudden moves!
If there is any uncertainty around the type of trust that has been created then legal advice should be sought to avoid unexpected problems further down the line.
Main image: bear in the woods, vladut-tomsa-EiO_KczEhog-unsplash
