A common issue presented to us by clients is where a child is a spendthrift. Clearly there is no desire to exclude such a child, but equally there is also a worry that that child will very quickly squander the clients’ hard-earned cash. Often the wish of the clients is to make sure that that child’s inheritance is used sensibly and wisely: to clear a mortgage, or buy a property and so on, rather than on ‘rubbish’.
The most obvious course of action for the client then, is to create a Will Trust, particularly a Discretionary Trust.
A ‘Trust’ is a very generic term. There are many types of trusts, but the most common is a Will Trust, created within a Will to be created on death. Will Trusts are, by far, the most common.
A discretionary trust works exactly as described in its name. It is flexible in that the trustees you appoint to manage the trust will make the decisions about when and how the beneficiaries receive the assets or the income.
Clients will almost always leave a letter of wishes with their Will which will help and assist the trustees in how they manage the trust and the circumstances under which the children inherit. It cannot dictate how the trustees act, otherwise the trust loses it’s ‘discretionary’ status. Rather it guides the trustees. Thus, it is important when selecting trustees that you are satisfied that they will carry out your wishes. So, in our scenario, rather than the spendthrift child inheriting a lump sum willy-nilly, a discretionary trust would allow the trustees to ensure that the money is used wisely, such as to pay off a mortgage or buy a home etc.
However, as sensible as that suggestion may appear, a potential drawback is that there is normally a negative impact for inheritance tax. One downside is the potential loss of the resident nil-rate band, and another is that there could be 10-yearly and/or exit charges when the money leaves the trust. But, the reality is that firstly there is a 2-year window in which to ‘appoint’ out of the trust, if circumstances allow and if the familial situation is favourable. Second, when given a choice, most clients are prepared for the estate to pay more inheritance tax if it means that their child/ren is/are protected from themselves.
A third factor also to consider is that the tax landscape today could be very different from that which might apply at the time. So all in all, many clients create a discretionary trust in the knowledge that, ultimately, decisions can be made many years in advance, by Trustees, after having considered ALL of the relevant, prevailing factors. “Let others deal with it at the time!”, in effect.
At Prior Knowledge we help clients navigate through the complexities of the different trusts, and we very often extoll the virtues of discretionary trusts, despite the potentially negative tax impact that might occur in the future. Consultations are always free and non-obligatory from either our Epping or Skipton offices.