Trusts and Inheritance Tax Planning

There are a number of advantages to using Trusts in Inheritance Tax (IHT) planning:

  • In contrast to Wills, Trusts are confidential documents.
  • The delays associated with probate can be avoided because trusts are usually treated separately from estates.
  • The settlor of a trust can also be a trustee which confers a degree of continuing control over the gift placed into the trust without sacrificing the IHT savings.
  • Trusts can ensure that the chosen person/s will benefit from the trust fund.

Which Trust To Use For Inheritance Tax Planning

There are three main types of trust that are commonly used in Inheritance Tax planning:

Bare Trust

Also known as an Absolute Trust, this trust enables the donor to make a Potentially Exempt Transfer for IHT purposes. This means that no lifetime IHT is payable regardless of the amount gifted which contrasts with Interest in Possession and Discretionary Trusts (see below).

Inheritance Tax and Trusts

As the trust is written on an absolute basis, the trust is fixed at outset for the chosen beneficiary/ies. The trust fund is therefore treated as belonging to the beneficiary and vests in their estate for IHT purposes.

Donor Dies After Seven Years

If the donor survives seven years from making the gift into the trust, the whole amount will fall out of the donor’s estate for IHT purposes.

Donor Dies Within Seven Years

If the donor dies within seven years from making the gift into the trust, the gift will become chargeable and IHT may be payable if the gift is not covered by the donor’s nil rate band. Taper relief may be available to reduce any IHT payable where death occurs after three years of the making of the gift.

Interest In Possession (IIP) and Discretionary Trusts

These types of trust give the trustees flexibility and control to choose whom they wish to benefit and when. Under an IIP trust, however, all the income must be paid to an IIP beneficiary.

Trust Charges On Transfer

Transfers of property to both IIP and Discretionary Trusts are treated as chargeable lifetime transfers for IHT purposes. This means that, if the amount gifted is in excess of the settlor’s nil rate band, IHT will be payable at 20% on any excess.

Ongoing Trust Charges

In addition to the lifetime transfer charges, Interest In Possession and Discretionary Trusts are liable to two other charges which are approximately 6% of the value of the trust fund in excess of the nil rate band:

  1. Exit Charge – when capital is appointed to a beneficiary.
  2. Periodic Charge – at each ten-year anniversary.

Making Lifetime Gifts

An effective strategy for making lifetime gifts is to:

MAKE GIFTS INTO DISCRETIONARY TRUSTS WITHIN THE AVAILABLE NIL RATE BAND

You should ensure that the value of the assets in the trust does not exceed the nil rate band at the time of the ten-year anniversaries to avoid the periodic and exit charges.

MAKE OUTRIGHT GIFTS OR GIFTS INTO A BARE TRUST WHERE THE DONOR HAS USED THEIR NIL RATE BAND

It is generally not worth making a gift that accelerates the 20% lifetime charge in order to save 40% death rate of tax at some time in the future. Nor is it good planning to trigger a CGT charge on a disposal that would be avoided on death.

If any or all of the nil rate band is used up by making lifetime gifts, and has not been effectively ‘reinstated’ by surviving seven years, this will reduce the amount of any nil rate band available to set against the donor’s death estate.

Where part or all of the nil rate band is used on first death, this will reduce the amount available for transfer to the surviving spouse/civil partner on their subsequent death.