Turning the Trust Tables

Life Interest Trusts

Let us consider the Immediate Post-Death Interest (IPDI) trust, a staple of modern English Wills since Gordon Brown’s changes to the taxation of trusts in 2006.  Solicitors routinely use an IPDI to capture the spousal exemption from inheritance tax: assets pass into trust on the first death, the surviving spouse receives the income as life tenant, and the capital is preserved for the children.  It sounds elegant, and indeed it is in theory.  

Difficulties, though, often arise where the IPDI is implemented without adequate financial analysis, without proper explanation, or indeed any, to the surviving spouse, and without serious consideration of her income needs in widowhood.  I have seen a couple of cases where the widow simply never understood what was planned and now feels like a pawn in a complicated game of taxation chess, often believing she is about to be sacrificed as part of a wider plan.

Overriding powers of appointment

The sting lies in the overriding powers.  Trustees, often members of the family with an inherent conflict of interest, may exercise a power of appointment to advance capital from the trust fund and distribute it to the remaindermen - amongst whom they often number.  This triggers a potentially exempt transfer, but more immediately, it depletes the fund from which the life tenant draws her income.  The widow, or, in some cases, the widower, is left materially worse off, watching the trust fund nominally put aside "for her benefit" being reduced in favour of people whose interests are directly opposed to hers.  This tends to be a source of consternation as the person struggles to understand how the deceased somehow failed to provide sufficient resources for her to maintain her standard of living.

The Conflicted Trustee

Trustee conflicts of interest are a well-documented pathology.  A trustee has a legal duty to act only in the best interests of the beneficiaries and must not place himself in a position where personal interests conflict with that duty.  Yet even professional trustees who also act for the testator's wider family regularly find themselves “on both sides of the table”.  I have seen cases where the same solicitor acts as trustee, drafter of the Will, and adviser to the very beneficiaries whose interests compete.  This creates irreconcilable conflicts of interest, but some trustees go ahead regardless.

What This Means

Trusts do not become oppressive by accident.  They become oppressive when advisers treat tax efficiency as the only variable or when no-one pauses to ask whether the surviving spouse will be able to live on what is left.  If your Will creates a trust, make sure:

• your spouse understands it;
• the numbers have been tested; and
• the people you appoint as trustees are different from those who stand to gain when the trust fund is depleted.  

If not, the trust you built to protect your family may be the very thing which divides it.