Financial advisers, whether or not they have been involved in
the setting up of an earlier trust, are frequently called upon to
assist with financial matters after a client or a relative of a
client has died. Frequently there are questions with regard
to the administration of a trust that the deceased had set up
during lifetime or there may be questions in relation to a trust
that has been created under the deceased's will. Judging from our
experience at Technical Connection particular problems often arise
in connection with loan trusts and other inheritance tax (IHT)
mitigation schemes. This month we will consider the
consequences of the death of a settlor under the different trust
Who is the settlor?
For tax purposes the settlor is the person who has provided
funds to the settlement. In most cases this will be the person
named as the settlor in the trust deed but it is important to
remember that this will not always be the case. The first thing for
an adviser to establish in relation to any existing trust is who
the settlor is. A part of this exercise will be establishing
what assets were transferred to the trust and when. This is
especially relevant where a trust has been created with a nominal
sum so it will not be apparent from the trust deed what assets have
been transferred and when.
Remember also that if two persons jointly create a trust or the
funds come from a joint account, they are both settlors and, for
IHT purposes, the trust is treated as two separate settlements even
if for income tax and CGT purposes there is only one.
It is also important to remember that where a trust is created
under a deed of variation within two years of death of the
testator, the settlor for IHT purposes is the deceased but for
income tax and CGT purposes the settlor is the original beneficiary
who varies their legacy.
Regardless of the tax position, for the purposes of trust
administration and any powers reserved to the settlor, the settlor
will be the person defined as such in the trust document.
Impact of the death of the settlor on trust
This will depend on the extent of any powers reserved to the
settlor. In many lifetime trusts the settlor will be one of
the trustees and, frequently, especially under the "standard"
discretionary or flexible trusts provided by life offices, the
settlor will also be the appointor under the trust, i.e. have the
power to appoint benefits under the trust during lifetime.
Obviously in such cases these powers, after the settlor's death,
will vest in the trustees.
The first job of an adviser will be to establish who the
surviving trustees are and whether there is a sufficient quorum for
them to make decisions.
If the settlor at the time of his death was the sole trustee
(either because no additional trustees have been
appointed - which is possible in England and Wales - or
because the trustees previously appointed have died or
retired and no replacement has been appointed - then who can
act will depend on the jurisdiction governing the trust. In England
and Wales and in Northern Ireland the legal personal
representatives of the last trustee (here the settlor) will act as
the new trustee. Therefore, probate will be necessary to establish
who these people are. These people will be able to act as new
trustees or will need to appoint new trustees to carry on the trust
In Scotland if the sole or last remaining trustee dies, the
executors of the last trustee must obtain a separate confirmation
(equivalent of probate) in respect of the trust assets. The
confirmation on the estate of the deceased is not sufficient, as
would be the case in England and Wales. Furthermore, once they have
obtained the separate confirmation on the trust assets, this will
only enable them to recover and deal with the trust assets as an
interim measure - effectively they are placed in the same position
in relation to the trust assets as they are in relation to the
deceased's estate. They can, for example, distribute the assets to
the beneficiaries who are absolutely entitled and can give a valid
receipt (i.e. over the age of 16) but where the trust is to
continue they must appoint new trustees - the confirmation does not
give them the title to act as trustees as such.
Many trusts will require a minimum number of trustees, usually
two, and many also include a 'no conflict of interest' clause
requiring an "independent " trustee if the existing trustees are
also trust beneficiaries and wish to exercise their power to
appoint benefits in their own favour. The word "independent" does
not mean "professional", so it should not normally be necessary to
appoint a solicitor or accountant unless this is desired. It is
important to remember that professional trustees will charge fees
Death of a settlor of a trust holding a protection
In this case the settlor will normally also be the life assured
and so their death will result in a claim under the policy
and the payment of the death benefit to the trustees. The trustees'
proof of title will be the deed evidencing their appointment, which
may be a separate deed or incorporated in the trust deed. Once the
trustees receive the policy proceeds they may well need advice on
how to deal with the funds. If it is not intended to distribute the
funds immediately, usually because the intended beneficiaries are
minor children, the trustees will need to obtain proper advice on
where to invest the funds.
If the trust is a discretionary or flexible trust, ideally the
settlor would have left a letter of wishes with the trustees.
But this will not absolve the trustees from properly exercising
their discretion. With protection policies, it is only when the sum
assured is paid on death that the trustees will begin to appreciate
the scale of their task.
Death of a settlor under a trust holding
In this case the trustees' functions are not likely to be
affected by the death of the settlor unless either the settlor had
retained some dispositive powers under the trust (see section above
about the settlor's power to make appointments) or the settlor had
reserved some beneficial rights under the trust for himself.
Typically there are two types of IHT scheme where the settlor may
reserve certain rights. These are loan plans and discounted gift
Death of a settlor under a DGT
Under a typical DGT the settlor carves out a series of capital
payments for himself, usually for life, while the rest of the trust
fund is held either for a named beneficiary under a bare trust or
for a class of beneficiaries under a flexible or discretionary
The death of the settlor will mean that the settlor's rights
terminate and the trust fund is available to the other
beneficiaries. Remember that the settlor's rights under a DGT have
no value in the event of his death. The only IHT implications will
be if the death occurs within 7 years of the original gift. The
trustees need to ensure that the life office is informed
immediately so that any payments made directly to the settlor's
bank account stop. If any payments are inadvertently made after the
date of the settlor's death, these should be refunded to the
If the settlor was the sole life assured under the bond held by
the trustees, the settlor's death will also give rise to a
chargeable event for income tax purposes as the bond will terminate
(assuming it was a life policy and not a capital redemption plan).
If the bond was effected on multiple lives and the settlor is not
last to die, the bond can continue and the trustees will need to
carefully consider the most tax-efficient way to surrender it if
they want to pay the benefits out to the trust beneficiaries.
Death of a settlor under a Loan trust
Under a Loan trust, the settlor lends a sum of money to the
trustees who invest it in a bond. The settlor remains entitled to
the repayment of his loan on demand whilst any growth is held for
the benefit of the beneficiaries, again under either a bare trust,
flexible trust or a discretionary trust.
When a settlor/lender under a Loan trust dies, the outstanding
loan forms part of their estate. Ideally there should be something
in the settlor's will (or a codicil) dealing with the loan
entitlement. For example, it is often recommended that the settlor
makes a provision in his will or a codicil that the entitlement to
the outstanding loan under the Loan trust should pass to his
spouse (if it is desired to take advantage of the spouse exemption
for IHT purposes) or to another individual, perhaps an adult child.
If there is such a provision then, as long as the outstanding loan
is not needed by the executors to, say, settle the estate debts, it
will pass to the named beneficiary who will effectively step into
the lender's shoes and be able to demand repayment by the trustees
on demand or leave the loan outstanding so that there will be no
need for the trustees to encash the bond
In the absence of a specific will /codicil provision, the loan
entitlement will pass into the residue of the estate. However, in
practice this will only happen if the funds are not needed by the
executors for anything else, e.g. to cover the estate liabilities,
specific legacies etc. Remember that the executors' primary duty is
to realise all assets of the estate, administer the estate and
distribute it to the beneficiaries named in the will.
Obviously, if the executors demand repayment of the loan
to the estate then the trustees will have to surrender the bond and
repay the loan. Often, for various reasons, it is not convenient to
surrender the bond and one of the questions we often get asked at
Technical Connection is whether the loan can be written off or
waived, or whether a deed of variation can be made so that the bond
does not need to be surrendered.
Here it is important to remember some fundamental facts. First,
the executors cannot write off or waive anything, it is
simply not in their power, and so what can happen in practice will
depend on whether the entire outstanding loan passes into
the residue (assuming there is no specific legacy of the loan
entitlement) and, if so, who inherits it.
If the money is not needed for any other purpose and the
outstanding loan has indeed passed into the residue of the estate,
the executors could, with the agreement of the beneficiary entitled
to the residue, assent the benefit of the outstanding loan to him
or her (or the trustees if the residue is left to trustees). It
would then be up to the beneficiary / trustees to decide if they
are happy to receive periodic repayments of the loan or call in the
outstanding loan, or indeed vary their legacy in favour of the Loan
trust or another beneficiary.
Another important point to remember is that a deed of variation
can only vary a disposition, i.e. a will provision, so the
beneficiary of the residue may make a variation in favour of
another beneficiary. That other beneficiary could be a trust,
including the Loan trust, that owes the money to the estate so that
the loan merges with the fund held for the beneficiaries of the
trust which will have the same result as being written off.
However, a deed of variation itself cannot "write off" or "waive"
Clearly it is the Loan trusts that cause most headaches for
advisers and trustees. In most cases problems will be avoided if
the settlor/lender leaves a specific legacy of their outstanding
loan to a named individual. So it is important that advisers give
advice on this when a Loan trust is being set up. Of course, it is
also important to remember that such a legacy will fail if the
funds are needed in the estate to repay the estate debts so nothing
can be guaranteed, but at least in most cases the problems involved
in dealing with outstanding loans will be avoided.