It’s possible to enhance the benefits of discretionary reversionary trusts with creative planning after the death of the settlor, as Paul Wilcox. Chairman, WAY Trustees Limited, explains.
Paraplanners and advisers are increasingly aware of the early use of discretionary reversionary trusts to manage the mitigation of potential personal Inheritance Tax (IHT) liabilities on death. However, there is one particularly beneficial feature of ongoing management by the trustees which is sometimes overlooked. This is both the ability, and the opportunity, to continue creative planning after the death of the Settlor.
Of course, one must not and cannot include a spouse as a (real or potential) beneficiary of a Settlor’s trust, without destroying the IHT benefit – because its settlement would constitute a gift with reservation. However, a bereaved spouse can safely be added by discretionary trustees to such a trust, after the death of the Settlor. This offers at least one, if not two, potential benefits.
The first important potential benefit to then be derived from the trust, is to assist the grieving surviving spouse at such a difficult time, should that survivor suffer financially. Which they may as a result of instantly losing the Settlors personal State Pension, and/or any reduction to their spouses employment pension (via conversion to a widow/ers pension). However, to compensate for any likely and understandable panic, or financial hardship, the trustees of the deceased Settlor’s trust can then support the survivor, via funding from the trust, to cover both urgent and ongoing living expenses.
Importantly this can helpfully be achieved by virtue of the survivor receiving interest free loans on a regular basis. This means the survivors IHT taxable estate, which may have been increased by virtue of spousal exempt transfers from the Settlor’s jointly or separately-held assets, will then be progressively reduced for IHT tax purposes – by a deduction from their ongoing estate by virtue of a growing debt (to the trust). For the couple, having already probably seen a reduction of their potential IHT liability (as a result of the Settlors original gift) this strategy will represent a further reduction in potential IHT for the survivor, who may also have inherited the remaining share of a valuable and loved family home. Such actions will not remove their Residential Nil Rate Bands.
Apart from the potential IHT benefit, this process may well allow the survivor to permanently remain in that family home, with all the costs which that involves (council tax, maintenance, heat and light), rather than being forced into an unwelcome move to ‘downsize’, especially during a period following the challenging loss of their partner.
The second important benefit is the incentive to retain the trust assets safely within the Settlor’s original trust for the future, including the growing loan to the surviving spouse, rather than to necessarily distribute funds to children, who themselves may already be, or likely in future to be, liable to IHT. This is a classic example of tax-efficient generation skipping – but only so long as the children do not actually need any funding. But if they do, that can also happen via interest-free, tax beneficial, loans on a similar basis.
It is our experience that the mature children of our trust Settlors are already often in their 50’s and heading inexorably into IHT territory themselves. The fact that our trusts have a potential term of up to 125 years does not present a challenge to continuing multi-generational tax planning.
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