Workshop: Private client: fair arrangements for vulnerable dependents

Clients with children, including ones with special needs, can find it difficult to decide how to leave their estate; they want to treat their children equally but are aware that their vulnerable child (V) has different needs to the others. These clients often do not make a will or pass V's share to a sibling on the understanding that it will be used for V's benefit.

If V inherits outright under intestacy, there is a risk that the inheritance will be wasted. V may not be able to manage money and may make unwise decisions. V may become attractive to fair weather friends. V is likely to lose entitlement to any means tested benefits currently received.

If the client leaves V's share of the estate to another child under his will, on the understanding that it will be used for V, other issues may arise. V's share is at risk if the sibling gets divorced, has financial difficulties or dies. The sibling may not use the money for V's benefit. The sibling will be taxed on income and gains on V's share. V may dislike having the sibling as custodian of V's money and the relationship between the two may become strained.

Letters of wishes

It is advisable for the client to leave his residuary estate on discretionary trusts for his children and remoter descendants (and any other beneficiary) with a detailed letter of wishes setting out how V is to benefit in relation to the other children.

There are clear benefits for V. The client can appoint trusted friends or advisors as independent trustees and custodian of the assets. The assets are protected in the trust from V's 'friends' and from V's own actions. V is not entitled to any assets as of right so means-tested benefits are unaffected, unless and until any distribution is made from the trust. There is the additional benefit of flexibility by including other children as beneficiaries and leaving the whole estate in trust.

If another child is in financial difficulties

when the trust comes into being, their share

of the estate can be held in trust until these are resolved. If not, any payment from the trust within two years of death is treated as a disposition by the testator for inheritance tax under section 144 of the Inheritance Tax Act 1984 (provided no interest in possession subsists in it,) so inheritance tax charges can be minimised if there is no need to keep other children's shares in trust.

There are other issues to consider with a discretionary trust, but these need not outweigh the overall benefit. A trust requires ongoing administration, but depending on the beneficiaries' needs and trustees' decision on investment, this has the potential to be minimised. Income in a discretionary trust is taxed at 50 per cent (45 per cent from next April) but this can be mitigated where appropriate by giving one or more beneficiaries a revocable income entitlement.

If the estate is large enough for ten year anniversary charges and exit charges to be an issue, the client can consider setting up pilot trusts in his lifetime on different dates, for assets to be transferred into these on his death, to reduce the overall tax liability.

High value estate

If the client's estate is of high value, a greater proportion of their wealth can be protected for V by IHT planning in the client's lifetime. The client can give money into a similar trust, but either within the nil rate band to avoid the 20 per cent IHT or by making regular payments from excess income. In addition to the other benefits, this helps V to develop a relationship with the trustees and begin to become financially independent from the client, rather than learn to deal with this on the client's death when bereaved. If V is disabled within the definition of section 89 of the Inheritance Tax Act 1984 then a gift exceeding the nil rate band may be made into trust for V under that section as it will be a potentially exempt rather than a chargeable transfer. To qualify, there must be no interest in possession in the trust and the terms of the trust must secure that not less than half of the settled property which is applied during V's life is applied for V's benefit. The value of that trust will then be liable to inheritance tax in V's estate under section 89(2).

Whether or not undertaking this planning, the client should advise other family members to consider it too or they might otherwise inadvertently leave assets outright to V. If they are reluctant to set up a trust in their will, they can be invited to make a gift into a pilot trust set up by your client.