Wills vs Trusts in the UK: How to Pass On Your Estate

In the UK, there are two main ways to pass on your assets: making a will or setting up a trust. The two differ significantly, both in how they work and in what they can do. It is important to remember that they are not mutually exclusive - a will is the usual starting point, whereas a trust can be a very useful addition in certain specific situations. Whether you should consider a trust depends largely on your financial and family situation - by identifying your needs and expectations for succession planning, it will be easier for you to make the right decision. The wills and probate rules described in this article apply in England and Wales; Scotland and Northern Ireland have different rules. In this article, we explain what you should consider when planning the future of your estate.

What is the difference between a will and a trust?

Before going into specific advice, let us first remind you of the difference between a will and a trust. While the latter term, trust, is reasonably familiar to people from the UK or who have lived here for many years, it is not uncommon for foreigners coming to the UK to find it confusing. Trusts are a feature of common law systems and may be unfamiliar to people from other legal traditions. For this reason, we will briefly describe what a trust is.

A trust is a legal arrangement, usually set out in a trust deed (or in a will), under which the person creating it (the settlor) transfers assets to trustees of their choice, who are usually tasked with properly managing the assets in their care and, in due course, passing them on to the beneficiaries. The details can differ from this description, as there are several types of trust - this issue, as well as many others related to trusts, is described in a comprehensive article on the subject entitled ‘Trusts - Everything you need to know’.

Making a will, on the other hand, is a common way of passing on property. A will is a legally binding document, drawn up by the owner of the property (the testator), which specifies what will happen to the property after their death. A will also names the beneficiaries (heirs) - the person or people who are to inherit the estate under the will. In addition, the will names executors, i.e. the people responsible for administering the estate after the testator’s death.

Inheritance Tax

One of the most important issues when choosing a form of estate planning is Inheritance Tax (IHT). The standard rate is 40%, but it is charged only on the part of the estate above the available tax-free threshold, i.e. in the case of Inheritance Tax £325,000 (or up to £500,000 if your home is left to your children, grandchildren or other direct descendants and the estate qualifies for the residence nil rate band). This can be a particular issue when the estate is made up mostly of property: the tax is normally due by the end of the sixth month after the person died, although tax on property such as a house can usually be paid in annual instalments over 10 years, with interest.

To illustrate how Inheritance Tax is calculated, let’s use an example. Suppose Peter inherits a house worth £450,000 and £50,000 in cash from his uncle. A nephew is not a direct descendant, so only the £325,000 threshold applies. The total value of the estate is £500,000, so subtracting the tax-free amount leaves £175,000, on which the tax is charged: 40% x £175,000 = £70,000. This tax is paid from the estate before Peter receives his inheritance. However, trusts can play a part in Inheritance Tax planning, although most trusts have their own Inheritance Tax rules - these are described later in this article.

Advantages and disadvantages of both forms of succession planning

In addition to Inheritance Tax, there are a number of other issues to be aware of when passing on assets. Below, we have put together a list of the pros and cons of both ways of managing wealth.

Wills - Advantages and disadvantages

The advantages of choosing a will include:

• almost complete control over the estate - a will can set out exactly who gets what, who is to be left out and even who is to look after the testator’s children (if they are minors). In England and Wales, certain family members and dependants can apply to the court if a will does not make reasonable financial provision for them, and the rules are different in Scotland and Northern Ireland;

• simplicity - making a will and understanding how it is carried out is much easier than using a trust properly and safely;

• the ability to update it - a will can be updated with a properly signed and witnessed codicil or replaced with a new will, and should be reviewed after major life events; in England and Wales, marriage cancels any earlier will;

• reducing the risk of family disputes - a clear, properly drafted will can reduce the risk of disagreement about how the estate should be distributed.

In turn, the disadvantages of a will are:

• the need to go through probate - assets that pass under a will (or under intestacy) usually need a grant of probate or letters of administration before they can be distributed, although some assets, such as jointly owned property or small savings, may not. In England and Wales, the grant of probate usually arrives within 12 weeks of applying, and the estate then has to be administered before beneficiaries receive their share, so it can take several months;

• Inheritance Tax - a will does not remove Inheritance Tax, but it can affect how much is due: for example, gifts to a spouse, civil partner or charity are exempt, leaving at least 10% of the net estate to charity can reduce the rate to 36%, and leaving your home to direct descendants can make the residence nil rate band available. Any tax due is paid from the estate;

• lack of asset protection - once your estate has passed to your beneficiaries, anything can happen to it and you have no control over it (for example, a beneficiary could squander or lose a large part of it through divorce);

• the risk of an outdated document - a poorly drafted will may not be well suited to future changes in the composition of your estate or family situation. Your circumstances may change in the years after you write your will, so it is worth reviewing your will regularly, for example after marriage, divorce, the birth of a child or a major change in your assets.

Trusts - Advantages and disadvantages

The main advantages of using a trust are:

• ability to protect assets - a trust allows you to influence how the estate is managed even after your death - this is what a trustee is appointed for;

• avoiding probate for lifetime trusts - assets placed in a trust during your lifetime are held by the trustees and do not normally have to go through probate, so beneficiaries may be able to benefit sooner after the settlor’s death. This does not apply in the same way to a trust created by a will, which is funded from the estate as part of its administration. A life insurance policy can also be written in trust: the proceeds are paid to the trustees for the beneficiaries, usually without waiting for probate, and in most cases they do not form part of the estate for Inheritance Tax;

• flexibility - a trust gives more options for succession planning than a will;

• Inheritance Tax planning - a trust can form part of Inheritance Tax planning, but most trusts are subject to their own Inheritance Tax charges (see below).

A trust does, however, have its drawbacks:

• legal complexity - to set up a trust correctly, it is strongly recommended to take specialist advice. A specialist will help you write the trust deed correctly, advise on managing the assets and make sure the whole arrangement is legally sound. This unfortunately generates additional costs;

• taxation - most trusts fall under the relevant property rules: Inheritance Tax is usually charged at 20% on transfers into the trust above the £325,000 threshold (more may be due if the settlor dies within 7 years), and the trust may also face 10-year anniversary charges and exit charges of up to 6%.

An estate worth less than £325,000

Let’s go through some practical examples to show when it makes sense to choose a will, and when a trust, as a form of estate planning. First, let’s consider a situation where the value of the estate is £300,000, with the house worth £250,000 and the remaining £50,000 being a car, some savings and a collection of rare books.

An estate worth £300,000 may be below the standard £325,000 Inheritance Tax threshold, but the tax position depends on matters such as other assets, earlier gifts and available allowances. A trust is not automatically a way to reduce tax, and estate planning may also address non-tax objectives. You can discuss will writing and estate planning options and any applicable fees directly with Citywide Wills.

However, if you have specific ideas about how the transfer of your estate should work and would, for example, like funds to be paid out when a condition is met or in an unusual way, a trust may be worth considering. In this example, if your aim is simply to pass your estate to your children, a trust brings no Inheritance Tax saving and a properly drafted will may be enough.

Transfer of a large estate

The situation will be quite different when you want to leave a very expensive property, worth, for example, £800,000, to your child. In such situations, a number of special rules are relevant - the threshold can rise when the home is left to direct descendants, and any unused threshold of a spouse or civil partner who died first can be added to the surviving partner’s threshold.

The most important of these is the so-called Residence Nil Rate Band (RNRB), an additional allowance of up to £175,000, which can raise the tax-free threshold to £500,000 (it is limited to the value of the home and reduced for estates worth more than £2 million). The £325,000 threshold is fixed until April 2031 and the residence nil rate band until April 2030. The RNRB applies only if both of these conditions are met:

• the home was the deceased’s residence at some point while they owned it (it does not have to have been their main home, but a property they never lived in, such as an office or a let property, does not qualify);

• the home passes to the deceased’s direct descendants - children (including adopted, foster and stepchildren), grandchildren and other lineal descendants, and their spouses or civil partners.

In addition, any unused residence nil rate band of a spouse or civil partner who died first can be transferred to the survivor’s estate. As a result, where both partners’ unused tax-free thresholds and residence nil rate bands are available and the home passes to direct descendants, an estate of up to £1 million can pass without Inheritance Tax. On the other hand, complications can arise that result in a very large liability to HMRC. It is definitely worth planning carefully when passing on large estates and using a specialist to do so.

When is it better to use a trust?

Trusts are used in a really wide range of situations - from the simplest, where the owner of an estate is planning for Inheritance Tax, to more complicated ones, where they would like to arrange the inheritance so that their spouse receives the income from the estate (for example, property purchased for rental or investment assets), but the children can take it over when they reach the age of majority (Interest in possession trust).

To illustrate how a trust can work in practice, we will use a simple example. Its protagonist is Michael, who owns a property worth £400,000 and £150,000 in cash. The house and money are to pass to his nephew, who is not a direct descendant and so does not benefit from the Residence Nil Rate Band. If this were done by way of a will, about £90,000 of Inheritance Tax would be due from the estate ((£550,000 - £325,000) x 40%).

Instead, Michael sets up a discretionary trust, whereby he allows the trustee to manage this estate, i.e. to look after the property, collect rent and perhaps even invest the cash. The trustee is also instructed to pass the assets to Michael’s nephew after Michael’s death, without waiting for probate. However, putting £550,000 into a discretionary trust is itself a chargeable transfer: Inheritance Tax is usually due at 20% on the amount above £325,000 (more if Michael dies within 7 years), and 10-year anniversary and exit charges can apply. The main benefits of the trust here are control and timing, and the tax position needs specialist advice.

Remember, however, that a discretionary trust has risks - the trustee has a great deal of discretion over the management of the assets, so Michael needs to be confident in the person chosen and to write the trust deed correctly, with the help of someone who is a specialist in the subject.

Summary

Wills and trusts are different tools for succession planning. Their suitability depends on your circumstances, the type of assets and the applicable law. Specialist advice can help you understand the options and their costs.

Extend Finance works with Citywide Wills, a specialist provider of will writing and estate planning services. If you would like to discuss preparing a will or explore whether a trust may be appropriate for your circumstances, you can contact Citywide Wills directly to discuss the options and any applicable fees: https://www.citywidewills.co.uk/contact .