How can we cut our controlling, greedy son-in-law out of inheritance AND avoid tax?
Our estate comprises a house worth £800,000 to £1million, plus approximately £300,000 in Premium Bonds and cash.
Our daughter has a controlling husband who has eyes set on her inheritance. We want to ringfence her share, whilst allowing our two sons immediate access to theirs.
In order to minimise inheritance tax we want to take advantage of the residential nil rate band.
We have been told that this is possible if we set up a trust, and the boys opt out of it within two years.
Inheritance plan: We want to ringfence our daughter's share of our home and savings, but allow our sons immediate access to their shares
Our understanding is that all beneficiaries would need to opt out as the trust precludes take-up of the additional allowance.
However, our solicitor says our daughter's inheritance can stay in the trust and this will not affect the residential allowance.
We would be most grateful for your opinion on this matter.
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Heather Rogers replies: It is understandable that you wish to protect your daughter and her inheritance in these circumstances.
Your solicitor is broadly correct regarding how a trust would work, as I will explain below.
Before you act, however, it is preferable and important to talk to your daughter if you haven't done so already.
I say that with the caveat that you and she are able to speak safely, about which you must exercise careful judgement, of course.
But the reason I believe it is better to have a discussion with her first is that although you want to protect her, allowing your sons to realise their shares of your estate but not your daughter might cause a bigger problem than it solves.
Additionally, it could leave her in a vulnerable position.
There is more on this topic below, but now let's turn to your questions about inheritance, and first have a look at the residence nil-rate band (RNRB) and how and when it applies, and then at what happens if you set up a trust.
What is the residence nil rate band?
The RNRB enables a residence to be passed to lineal descendants. It is worth up to £175,000 (£350,000 for a couple) on net estates below £2million.
On net estates over £2million, the RNRB is reduced by £1 for every £2 it exceeds £2million.
It is claimed when someone dies as part of the inheritance tax reporting.
To qualify for it, the deceased must:
- Own a home or a share of one which is included in the estate;
- Have lineal descendants who will inherit the home or a share of it on death.
The maximum that can be claimed is equal to the value of the person's home that passes to their direct descendants, subject to any reduction to the allowance on estates exceeding £2million.
What qualifies as a 'residence'?
A residence is any property that the deceased lived in as their home and was included in their estate.
It doesn't have to be their main residence, or have been lived in or owned for specified period of time.
For UK estates, it can even apply to a property overseas.
However, the RNRB can only be applied to one property.
Any property that the deceased owned, but never lived in, for example a rental property owned by the deceased, is not a residence and is not eligible for the RNRB.
What is a lineal descendant?
Children, grandchildren, great grandchildren, and so on. But for RNRB purposes a child also includes:
- Step children, but they must be the children of the spouse/civil partner of the deceased
- Adopted children
- Foster children
- Children for whom the deceased was a guardian
- Spouses or civil partners of the child, grandchild, great grandchild, and so on.
What if there is no home or the deceased downsized prior to death?
When someone has sold or given away a home, or downsized to a less valuable home before they die, their estate may still be able to get the RNRB if they qualify for a downsizing addition.
You may hear this described as a 'qualifying former residential interest'.
To qualify, all these conditions must apply:
- The person sold, gave away or downsized to a less valuable home, on or after 8 July 2015
- The former home would have qualified for the RNRB if they'd kept it until they died
- Their direct descendants inherit at least some of the estate. However, the RNRB is restricted to the value of the property, so a property worth £150,000 would only receive £150,000 RNRB and if only half of the property was left to lineal descendants, then only £75,000 would qualify for RNRB.
What happens if you have a will trust and want to use the RNRB?
Trusts created in wills are usually discretionary trusts. In this type of trust, the trustees have complete control over the assets and the income generated from them and they decide how and when to give the income and assets to the beneficiaries.
Depending on the trust deed, trustees can decide what gets paid out to which beneficiaries - this could be income or capital – how often and whether there are any conditions applied.
Discretionary trusts are often used to protect family assets.
As the beneficiaries do not by the very nature of the trust have any entitlement to the trust fund itself, it does not usually form part of the beneficiaries' estates on divorce, bankruptcy or death.
You might wish to take particular note of that latter point regarding what might happen to whatever is in the trust should your daughter and her husband get divorced, and consult your solicitor about it.
When the home or a share of it is left to a discretionary will trust, then no RNRB can be available, as the trust does not meet the definition of a lineal descendant, even if all the beneficiaries themselves are.
If, however, within two years of death, there is a deed of appointment of trust assets by the trustees to a lineal descendant or descendants, then this would be treated as if the assets had been left to the direct descendant outright.
The RNRB would then be available to claim but only equal to the value of the person's home that passes to their direct descendants.
In your case, if the value of your sons' share of the property passing is equal to, or more than, the maximum RNRB available on death, then the full RNRB will be available to claim, providing the estate is below the £2million as current rules stand.
However, if the value of the property passing to them is less than the maximum RNRB available, the RNRB will be restricted to the value of the property passing directly to them.
Note however, that if your daughter's share remains in trust after the two-year period, then 10-yearly inheritance tax charges and exit charges on assets leaving the trust could apply.
Similarly, depending on the assets and whether income is generated, yearly tax returns could be required.
What action should you take now
As I have explained above, I believe it is important to talk to your daughter under these circumstances, and your sons too if you have not yet done so.
You may decide the best course is to go ahead with your plans for a trust no matter what her reaction may be, but if forewarned she will hopefully be better prepared for when her husband eventually learns your plans for her inheritance.
You should naturally give careful thought to appointing suitable trustees.
Since you have seen a solicitor, I assume you have drawn up wills. I would leave a 'letter of wishes' with both your wills too, about which your solicitor can advise you.
I do not know how serious the situation is with your daughter and her husband based on what you have said here.
However, I am going to err on the side of caution and suggest some organisations you might want to contact to discuss your concerns in confidence, if you feel it is warranted. I wish you and your family all the best.
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