In life, as in the microcosm that is financial services, there are examples of finely judged arguments to be had over the value of particular courses of action. Indeed, such arguments form the basis and prove the value of advice in a complex world.
Where such arguments are finely balanced with advantages and disadvantages, debates as to their value can be positive and informative. However, where they are simply examples of structures that can be used to justify product sales – in this case, investment bonds – then it is neither. Probate trusts are very much an example.
There are a number of justifications extolled for the use of probate trusts, including:
- Avoidance of the significant increase proposed by the Ministry of Justice in probate fees.
- Reduction in the cost of probate itself by virtue of a client having a smaller estate.
- The benefit of certainty given the apparent increasing propensity to challenge wills.
Taken together, a compelling case. Or is it? First off, while it is the case the MoJ proposed significant increases in probate fees based on the value of a deceased’s estate, there have been no developments for some considerable time since the original announcement. It seems clear the consultation process has stalled with no timetable for any further action.
Furthermore, even if the original proposals were brought in full, the assets held in a probate trust would need to be of considerable value if significant savings were to be made.
Turning to the cost of probate itself, while some practitioners will make a charge for probate or estate administration based upon the value of a deceased’s estate (an ad valorem charge), this is not always the case. Indeed, the better practitioners would charge for such services based upon the complexity of the deceased’s estate rather than its value.
This leaves certainty of succession and, while I will accept that certainty brings with it some peace of mind, this is an insufficient reason to justify the cost of establishing and running such a trust, the selection of specific underlying investments and to outweigh the negative tax implications that come with their use.
Stings in the tail
So what are the potential downsides to using a probate trust? We should first consider the options: bare trust or a discretionary trust. In practice, a bare trust can be dismissed fairly quickly. The settlor will transfer any ownership of any investments into a trust for his or her own benefit. There will be a trustee but it will be essential to have an additional one to ensure, following the settlor’s death, that this trustee can deal with the trust assets, holding them for the benefit of the deceased’s estate and the individuals who would be entitled to them under the deceased’s will.
By definition, it would still be necessary to obtain probate before the trust can be distributed. Therefore, a bare trust probate is not fully effective in avoiding the need for probate.
A discretionary trust is a more flexible approach, as it does not count as part of the deceased’s estate for probate purposes. It is, therefore, fully effective in avoiding probate delays, as well as retaining access to the trust fund for the settlor and retains flexibility over choice of who will benefit from the trust on the settlor’s death. However, that is not the end of the story:
- The settlor should not have unrestricted access to the investment as this could raise the question of whether the trust was a sham, requiring the trust only to appoint benefits with the agreement of two independent trustees.
- As any gift will be a gift with reservation of benefit, the value transferred into trust must remain within the settlor’s available nil-rate band. Any excess would, in practice, be subject to 25 per cent lifetime inheritance tax charge.
- Even though the gift is a gift with reservation of benefit, there will still be the potential liability to periodic and exit charges. If the gift to trust exceeds the relevant reporting limits then a return will be required to HM Revenue & Customs on forms IHT 100 and IHT 100a (and if this involved a life assurance policy, form D34).
- On the death of the settlor, he or she will be treated as making a chargeable transfer to the trust of the value of the trust fund, which will use all or part of the transferable nil rate band and, by definition, affect the amount of any transferable nil rate band available where there is a surviving spouse or civil partner.
- If the settlor dies within seven years, there could be a potential double charge to IHT by a virtue of a combination of the settlor having made a chargeable lifetime transfer and having reserved a benefit in the trust. While the IHT double charges relief will apply, there are still circumstances where an IHT liability will arise which otherwise would not have been the case.
There are other issues in relation to transfers of assets into trust and capital gains tax, the tax issues on the realisation of trust investments and the lack of certain investment freedoms within a trust. All in all, given the limited benefits provided by probate trusts, the value is dubious and a good example of the saying: “if something looks too good to be true, it often is”.
Tony Mudd is divisional director of tax and technical support at St James’s Place