Sometimes its better to keep things simple. That’s why we’re asking, do you really need a complicated Bloodline Trust Will?
What is a Bloodline Trust Will?
Essentially a Bloodline Trust is a Discretionary Trust that is included as part of your Will.
Bloodline Trusts, which are also known as Family Protection trusts or Wealth Protection Trusts, help to ensure wealth and assets remain within your family. They are recommended to clients as they help to ensure any inheritance you pass to your children is not at risk should one of them get divorced or declared bankrupt.
Setting up a Bloodline Trust Will ensures that inheritance can only be accessed by your children, your grandchildren or other generations directly related to you. Those who have married into your family have no access to funds.
Whilst this sounds great, the administration and taxation of Bloodline Trusts is not always simple and they are just not needed for most people.
The effect of a Bloodline Trust on the Residence Nil Rate Band
If you pass away and you leave your property to a direct descendant, you may be entitled to claim the residence nil rate band. This is an extra tax free amount that you can claim. For example, you are married, you have two adult children and your property is worth £500,000. You have other assets and savings worth £250,000. The total value of your estate is
£750,000.
Ordinarily, as a married couple, your inheritance tax nil rate band would be £650,000 (£325,000 each). Therefore, when you have both passed away, you would pay a total of £40,000. (Total estate – nil rate band x 40%)
However, if you leave your property to your children (or grandchildren etc) you are also entitled to claim the residence nil rate band, currently, for a married couple, this is £350,000. So the total tax free allowance is currently £1 million!
Excellent news, using the residence nil rate band means that your family has no inheritance tax to pay!
However, if you are leaving your children’s inheritance into a Bloodline Trust, YOU ARE NOT ENTITLED TO CLAIM THE RESIDENCE NIL RATE BAND. Therefore, your family still have to pay the £40,000 inheritance tax.
There are ways that you can appoint the property out of the trust but this will need to be done by a lawyer, who will ask to be paid for their time and frankly, what is the point of having the trust in the first place if it will not protect the value of your property.
If you want to learn more about the Residence Nil-Rate Band try this article by the Financial Times: https://www.ftadviser.com/property/2018/11/26/getting-to-grips-with-the-residence-nil-rate-band/
How are Bloodline Trusts Taxed?
The taxation of Discretionary Trusts is rather harsh, this is to discourage people from hoarding their wealth within a trust. There are several ways that the trusts are taxed:
Trust Income
You would hope that the inheritance you pass to your children gains them some extra income whether that be through bank interest, rental income or dividends from shares. The first £1,000 of income that the trust receives is taxed at the basic rate. For example:
The Smith Family Trust income 2019-2020:
Income Tax Rate Tax to Pay
£500 from Property 20% £100
£300 bank interest 20% £60
£200 dividends 7.5% £15
TOTAL £175
However, if the Bloodline Trust starts earning a higher amount of income, the tax rates increase dramatically. For Example:
The Jones Family Trust 2019-2020:
Income Tax Rate Tax to Pay
£6,000 from Property (£1,000 taxed at 20%) £200 (£5,000 taxed at 45%) £2,250
£500 bank interest 45% £225
£3,000 dividends 38.1% £1,143
TOTAL £3,818
As you can see, the amount of tax to pay on income can quickly add up. If the income is paid to a beneficiary and they are a lower rate tax payer, they can reclaim some of the tax. However, they would need to complete an annual tax return to do this.
The 10 Yearly Charge
You hope that your children will be sensible with their inheritance and that they will still have some left 10 years after you have passed away. After all, the purpose of the trust was to ensure some money passed to your grandchildren.
A Discretionary Bloodline Trust, that contains more than £325,000, will usually have some tax to pay on the 10 year anniversary of the trust being set up. The tax rate payable is 6%.
Example:
The Jones Family Trust- Set up on 10 January 2010. The amount in the trust on 10 January 2020 is £400,000. For ease, lets say that no money has been taken out of the trust in the last 10 years.
The amount of tax payable on the 10 year anniversary is:
£400,000 - £325,000 (the Inheritance tax nil rate band allowance) = £75,000 x 6% = £4,500 tax owed.
This is a much simplified version, the taxation of discretionary trusts is complex and most trustees will use a specialist accountant to help them- you can imagine how much they will charge!
Exit Charges
So, what happens if your children actually want to spend some of their inheritance, or gift some to your grandchildren?
When money is distributed to beneficiaries (taken out of the trust), an inheritance tax exit charge could apply. The way to work out how much the exit charge will be is complex, for example:
Mr Jones dies in May 2017 and leaves £400,000 into a Discretionary Will Trust. After two years, the Trustee of the Will Trust (his Daughter) gives £100,000 to her son to buy his first property.
It is necessary to work out the effective rate of tax applicable to the trust:
The first thing to find out is the current inheritance tax nil rate band this is currently £325,000.
So you take £100,000 (the amount being taken out of the trust) from £325,000 = £225,000
Next you take £400,000 (amount in the trust) minus £225,000 (as above) = £175,000 x 6% = £10,500
The effective rate of tax for the trust is £10,500 / £400,000 = 2.625%
The trust has completed eight quarters of the ten year period, therefore the tax is reduced proportionately by 8/40. (40 because there are 40 quarters in 10 years.)
The exit charge is £100,000 x 2.625% x 8/40 = £700.
So, the total amount payable is £700
The maths is even more complicated if more than 10 years have passes since the trust was started. Do you think that your children will want to do this every time they want to spend some of their inheritance? If not, then they will probably need to employ a specialist accountant to help them.
Find out more about the taxation of trusts here: https://www.gov.uk/trusts-taxes
Conclusion
So, you need to think very carefully about whether a discretionary bloodline trust is right for you and your family. We can properly advise you on the tax consequences of using this type of trust and whether is it suitable for you and your family.
This article only scrapes the surface on what your children will need to do to administer the trust, we don’t even mention the Trust Registration Service, Annual Returns or Trustees duties…
There are certain circumstances where a bloodline trust is the right way to go, for example if one of your children is vulnerable, for example if they disabled, an addict or separated but not divorced.
If you would like to find out more about the different types of Wills, why not request our free information booklet here: