Minor issues with trusts for minors

Trainee Solicitor Chris Mills and Partner Brian Tan discusses below how to ensure your beneficiaries are responsible when inheriting a substantial amount at such a young age.

A common concern of those making Wills is whether their children, grandchildren or other beneficiaries will be responsible enough to inherit a substantial amount of money at a young age.

The law generally provides that minor beneficiaries do not inherit until they reach the age of 18. However, many testators (those making a Will) feel that these provisions provide insufficient protection, given the amount of money at stake.

This problem can be overcome in a number of ways. Firstly, a testator can specify that a child’s inheritance is contingent upon them reaching a particular age. Alternatively, more complex trust structures can be used. For example, a testator could allow nominated trustees to decide if and when money is paid out to minor beneficiaries, or (s)he could limit the child's inheritance to an income rather than capital.

Whilst these solutions offer attractive ways to postpone a child's inheritance, there can often be negative tax implications resulting from these options, and particularly in the case of sizeable estates.

Firstly, the trusts specified above often do not provide the beneficiary with a right to the income generated by the trust. If the income generated by the trust is accumulated in the trust rather than paid out to the beneficiaries, that income tends to be taxed at a higher rate.
Secondly, discretionary trusts and contingent gifts tend to create a particular form of trust called a ‘relevant property trust’. This means that the trust may be subject to ongoing charges to inheritance tax throughout the life of the trust, and also whenever money leaves the trust to be paid to a beneficiary. This depends on the value of the trust fund. Whilst there are useful exemptions for the testator’s own children, a testator’s grandchildren and other minor beneficiaries are not afforded such leniency. The ongoing charges can amount to as much as 6% of the value of the trust every 10 years, or on a proportionate basis. The charges will apply in addition to the inheritance tax which is paid when the testator passes away (at up to 40%).
Thirdly, additional tax-free allowances have recently been introduced which, by 2020, will total £350,000. These allowances apply specifically where the family home is inherited by certain people, most notably the testator’s children or grandchildren. Due to subtle nuances in the legislation, the trust the structures mentioned above may jeopardise the estate’s entitlement to these additional allowances. This is because the beneficiary is not treated as inheriting the home immediately after the testator’s death. Again, there are useful exemptions for the testator’s own children.

Ultimately, these tax implications will have to be weighed against the risk of a beneficiary wasting his or her inheritance on a new Ferrari.

However, steps can be taken to reduce the negative tax implications mentioned above, whilst still protecting the child's inheritance.

For example, provisions can be inserted into the Will to give beneficiaries a right to the income of the trust fund, as opposed to the capital, prior to a certain age.
Alternatively, the trustees may have powers to release money early if it transpires that the beneficiary is responsible enough after the testator’s death. Doing so within certain time periods can secure the additional tax-free allowances and minimise futures tax charges.

The rules governing Wills, trusts and taxation are extremely complex, and each estate must be assessed on a case-by-case basis. Professional advice should therefore be sought both when the Will is prepared and at the time of death.

Given that inheritance tax often applies at a rate of 40%, the benefits of seeking professional advice cannot be overstated. The result could be savings of thousands of pounds. Such savings would maximise the financial support which is available for young beneficiaries, to help them through what is undoubtedly an extremely difficult time in their lives.

This article was written by Chris Mills who is a Trainee Solicitor and Brian Tan who is a Partner within our Private Client department.