Workshop: private client

The problem

I recently reviewed a client's trust created two years ago with other advisers to protect assets from long-term care costs. He settled the matrimonial home (owned entirely by him, worth £300,000 then but about £350,000 now) on interest in possession trusts for himself. His will exercised the power given to him by the trust to grant his wife a successive life interest in the trust on his death, and left his £175,000 estate to her for life. Having been in good health two years ago, he was now seriously ill and unlikely to survive another year.

Ignoring deprivation of capital arguments surrounding trusts created with this intention, my client was surprised that there would be an inheritance tax liability on his death, even if his wife survived him and even if the value of the joint estate (whether held personally or in trust) was below £650,000.

Considerations

Practitioners will be aware that:

1. Transfers into relevant property trusts do not incur IHT entry charges if within the settlor's nil-rate band.

2. IHT charges may arise every ten years and on exits.

3. As a beneficiary of the trust, the settlor reserves a benefit and is caught by section 102(3) of the FA 1986.

4. The testamentary gift of my client's residuary estate qualifies as an immediate post-death interest (IPDI) under section 49A of the IHTA 1984 and so qualifies for the section 18 spouse exemption on his death.

The mistaken belief was that, on my client's death, the trust fund (treated as part of his estate due to his reservation) would also qualify for spouse exemption because of the successive life interest for his wife. If correct this would also mean that, on the wife's death, any IHT charge would be subject to both her nil-rate band and the transferrable nil-rate band from his estate.

To qualify as an IPDI, the wife's interest must satisfy section 49A. One of the conditions is that 'the settlement was effected by will or under the law relating to intestacy'. While her entitlement is effected by a will (i.e. the husband's exercise of his power), the trust itself was not.

It is not an IPDI so the full value of the house at the husband's death is chargeable to IHT with no spouse exemption available. If it exceeds the husband's available nil-rate band, IHT is payable. Not many married couples expect to pay IHT on the first death.

The trustees of my client's trust decided that his reduced life expectancy reduced the need to protect capital for him for the longer term and so appointed the fund to him. It can now pass through his will. For seven years from the trust's creation, its value reduces his nil-rate band, so we added a nil-rate band discretionary trust to his will which takes part of the value of the house out of his wife's IHT estate, with the balance passing, free of IHT, to the IPDI trust for her.

If he survives seven years, the nil-rate band trust can be removed, since his own nil-rate band will then be available to transfer to his wife.

When advising similar clients considering such trusts (whether married or in a civil partnership), thought should be given to equalising the estates through inter-spousal transfers before settling assets to ensure each party has an estate comfortably within their own nil-rate band. This should avoid IHT on the first death provided the value of the asset in which the benefit is reserved remains within the nil-rate band. The impact of a reduced transferrable nil-rate band for the second death should not be overlooked.

The IHT exposure of a settlor who has no spouse or civil partner is the same as if he had not created the trust because no section 18 exemption is available.

Asset protection trusts are not new and remain a legitimate way to preserve wealth and provide flexibility. They are increasingly attractive to those for whom IHT will not be an issue if they retain ownership of all assets. Unfortunately, practitioners' forums are reporting aggressive marketing techniques in this area accompanied by less than adequate advice on the risks involved.