Setting up trusts in your will

Before spouses and civil partners could inherit each other's unused tax-free allowance, one way you could make sure your tax-free allowance was not wasted was to set up a discretionary trust in your will. 

Using 2011-12 figures, the will would leave £325,000 to the trust - which could be a share in the family home - and the trustees would have the right to allow anyone from the specified beneficiaries to live in the home. The surviving spouse would be included amongst the beneficiaries to live in the house. The bequest to the trust would use the £325,000 tax-free allowance and would not be part of the surviving spouse's estate. A variant on the scheme has the spouse inheriting the home outright but issuing an IOU to the trust for the £325,000 left to it under the will. 

Another option may be to set up an interest-in-possession will trust giving your surviving spouse the right to remain in the home during their lifetime, povided the trust did not comply with the rules for an immediate post-death-interest trust. 

Some experts have suggested that being able to inherit your spouse or civil partner's allowance means that will trusts are now redundant, but that depends on your view about possible future increases in the tax-free allowance and the assets you expect to leave.

The use of trusts can also be relevant if you are concerned about your partner remarrying after your death or the assessment of your partner's assets should he or she move into a care home. The is a complex area, so seek advice from a tax expert.

Inheritance tax and trusts

A trust is a legal arrangement where one or more people (the trustees) hold assets (the trust property) to be used for the benefit of one or more people (the beneficiaries) in accordance with the rules of the trust. The person who gives the trust property is called the settlor. There are two main types of trust.

* interest in possession trust: The beneficiary/ies has the right to use the trust property or receive income from it during their lifetime or for some other specified period. They are said to have he life interest. Other beneficiaries, or sometimes, the same people, have the right to become the outright owners of the trust property when the life interest ends - this is called the reversionary interest

* discretionary trust. The trustees decide who among the beneficiaries will receive payments of income and/or capital from the trust and when this well be, subject to whatever the trust rules say.

Under the discretionary trust regime, gifts to the trust are taxable, so there is inheritance tax to pay at the time of the gift unless it falls with the £325,000 tax-free allowance. 

In addition, there is an inheritance tax charge every ten years on the value of the trust property and an exit charge every ten years on the value of the trust property and an exit charge when assets leave the trust. Before 22 March 2006, interest in possession trusts and certain discretionary trusts, called accumulation and maintenance (A&M) trusts, were subject to a more lenient regime under which gifts to the trust counted as potentially exempt transfers, there were no ten-yearly or exit charges and, where someone had a life interest, they were treated as if they owned the trust assets for inheritance tax purposes.