The benefits of including a life interest trust in a will

The fact that assets that pass to a spouse do so free of inheritance tax while assets passing to children are taxable serves only to complicate matters. 

A solution frequently arrived at by couples is for each to complete a will leaving everything to each other and for the children to receive the assets on the second death.

Such wills typically allow the parties to change their minds in future — this is in keeping with the long-held principle of freedom of testamentary disposition.

Mutual wills

However, the law allows an exception to this rule, whereby the parties bind each other to the terms of the wills they have completed together.

These exceptions are the known as “mutual wills”. This power to control matters from beyond the grave may sound appealing, but a recent case in the High Court demonstrates the strict criteria that must be met to put mutual wills in place.

The case concerned a couple who had been married for 45 years. Each spouse completed a will that gave everything to the other on the first death and then to the four children on the second death. Three of the four children were the husband’s children from a previous relationship.

After the husband had died, the wife completed a new will that disinherited the three children that were not her own and left everything to the remaining child.

The disinherited children claimed that the wills the couple had completed together were mutual wills, meaning that the terms of the wife’s later will did not stand.

Mutual wills are created only where there is an agreement that amounts to a contract between the two people completing the wills — known as the testators. To meet the criteria there must be unequivocal evidence that both parties intend the wills to be irrevocable and remain unaltered.

It is best for the agreement to be written, allowing the testators to clearly express their understanding that they are no longer free to choose who is to inherit their estate.

Mutual wills are created only where there is an agreement that amounts to a contract between the two people completing the wills

It should be stressed that simply trusting the other to honour an agreement is not enough. Indeed, in reaching its decision to refuse the disappointed children’s challenge to the later will, the court said that the trust expressed by the husband that his wife would not change her will after his death was evidence that he did not think there was a need to create a legal agreement. This shows that a moral obligation to each other holds no sway in a court of law. 

The reason that mutual wills are the exception to the rule, that an individual is free to change their mind at any time, is that circumstances change.

For example, if following the death of one of the testators, the intended beneficiary of both wills acted in an egregious manner towards the surviving testator, mutual wills would oblige that surviving testator to pass assets to someone who had mistreated them. It is for this reason that an unambiguous intention to deprive a person of the freedom to change their mind is required to complete mutual wills.

A testator seeking to provide for a spouse and their children should consider inserting a trust in their will, rather than completing mutual wills. A trust allows a testator to choose trustees whom they trust to carry out their wishes after their death.

Life interest trusts

A life interest trust allows a testator to give their spouse a right to reside in property held in the name of the deceased and to income generated by the deceased’s assets — thus providing a measure of security for the surviving spouse. On the second spouse’s death, the assets that belonged to the first to die pass to their own children, meaning the children do not miss out on their inheritance. 

The life interest trust can be drafted so that assets can pass to the surviving spouse or to any other beneficiary if needed. For example, if the spouse required significant funds to cover the cost of care that the income alone would not cover, funds could be released from the trust to meet this cost.

It is the trustees who would decide whether to make these funds available. In deciding whether to do so, the trustees would be guided by a letter of wishes composed by the testator in which they can outline how the trust fund should be used to help a beneficiary if needed.

Given the discretion afforded to the trustees to make funds available, it is crucial that the testator appoints someone they trust. The trustees could include the surviving spouse or any of the children.

Alternatively, the trustees could include a professional who could act as an impartial and dispassionate party at a time when tension between the spouse and the children could be increased.

Given the discretion afforded to the trustees to make funds available, it is crucial that the testator appoints someone they trust. The trustees could include the surviving spouse or any of the children

Assets passing to a life interest trust do so free of inheritance tax. This means the tension caused by identifying which bank account to “plunder” or which asset to sell to settle the tax liability is alleviated.

An alternative to the life interest trust is a fully discretionary trust leaving everything in the testator’s estate to the trustees to manage. While this provides the trustees with significant flexibility to react to circumstances as they are presented at the testator’s death, this type of trust denies the surviving spouse the right to reside in trust property and the right to trust income. The assets passing to the trust would also be chargeable to inheritance tax on the first death.

Including a trust in a will may not be appropriate as it could restrict the use of assets that are available to the surviving spouse. This problem can be alleviated were the couple put funds in a joint bank account, which would pass automatically to the survivor and consequently outside the terms of the trust.  

Richard Burgess is a director at Moore Kingston Smith