Inheritance Tax is still a concern for many families, despite the new Main Residence Nil Rate Band adding up to £350,000 to the standard IHT threshold.
Making gifts or using Trusts usually take seven years to become completely free from Inheritance Tax (IHT). But an investment in a Business Property Relief (BPR) qualifying company can be passed down to beneficiaries free of IHT on the death of the shareholder, provided it has been held for at least two years at that time.
At FAS, we are strong advocates of using Trusts as well as BPR investments to mitigate a potential IHT liability and always give full consideration to both options when discussing Inheritance Tax Planning with our clients.
Don’t Give Away More Than You Can Afford
Trusts are a specialist planning tool that may not be suitable for everyone. We have prepared this guide to address some common questions, concerns and pitfalls that can arise when considering Trusts.
Remember, a Trust is a completely separate legal entity. Once you have gifted an asset into a Trust, it is no longer yours. In most cases, you cannot receive any benefit from the asset.
If you are thinking about gifting money into Trust, think about how much you would be prepared to give away without the Trust structure.
The main benefit of a Trust is that it gives you some control over how and when the gift is distributed. So, if you’re sure that you want to set aside £100,000 for your grandchildren, but don’t want them to receive it as a single lump sum when they turn 18, a Trust could be the answer.
But if there is a chance you will need the £100,000 to pay care home fees, a straightforward Trust won’t help with this.
There are certain Trusts which allow you to retain some access to the capital or to draw an income. These are known as Gift and Loan Trusts and Discounted Gift Trusts. However, these carry some restrictions, and may not be as effective for IHT purposes as a full Trust.
Trustee investments should be considered as part of your wider financial plan. A simple cashflow projection can help you decide how much you can afford (and are prepared) to give away.
It’s Not Just for Gifts
A Trust can be set up even if you don’t have any money to gift.
The simplest way to use Trusts in IHT planning is to ensure that your life insurance is payable into a Trust. This offers the following advantages:
- No IHT when the benefits are paid out
- No IHT on second death, as with the benefits in trust, the surviving spouse’s Estate has not increased in value
- Benefits are paid out more quickly, bypassing probate procedures
- Life policies can be set up for family protection, or specifically to cover an IHT liability.
- Pension death benefits and employer death in service plans can also be paid into trust.
Absolute or Discretionary?
An Absolute Trust (or Bare Trust) works in the same way as a gift. The asset is earmarked absolutely for one or more beneficiaries under the terms of the Trust. There is no scope for the Trustees to apply their discretion.
This means that once the Trust is in place, you no longer have any control. However, the gift will drop out of your Estate after 7 years. The investment is taxed as if it belongs to the beneficiary.
A Discretionary Trust, as the name implies, allows more control over the investment. The Trustees can decide how and when to distribute the money. The beneficiaries can also be changed or selected from a particular group.
However, a Discretionary Trust offers certain disadvantages:
- If the gift is over £325,000, IHT of 20% applies immediately. A further 20% is then due if you die within 7 years.
- Further IHT charges apply every 10 years. This is broadly 6% of the value over £325,000, with adjustments made for any withdrawals taken.
- Exit charges may also apply when money is distributed from the Trust.
These points can mostly be mitigated with proper planning. But considering that larger Trusts in particular may incur additional fees in respect of legal and tax advice, a Trust can prove very expensive.
IHT is Not the Only Tax
Discretionary Trusts are subject to higher rates of tax than individuals.
Income is taxed at 20% on the first £1,000 only. Thereafter, income is taxed at 45% – an individual would need to earn £150,000 before paying this rate of tax.
If the Trust realises a capital gain, the first £6,000 is exempt from tax. This is half of the allowance available to an individual investor. Any gains over this amount are taxed at 20%, the same rate payable by a higher rate taxpayer.
Detailed planning is required to make sure that the strategy works, taking all taxes and costs into account.
The Investment Strategy Matters
The portfolio selected for a Trust investment may be different from an individual’s own funds.
It could be appropriate to use a higher risk portfolio on a Trust, to maximise the growth potential so that the money can last for several generations. Alternatively, the money might be required in the short term to provide an income, in which case a lower risk strategy would be suitable.
Taxation is an important factor. Using an Investment Bond as a wrapper for the investments can be effective, as there are no tax implications unless money is actually withdrawn. This means that funds can be switched within the bond without worrying about Capital Gains Tax. Similarly, interest and dividends produced within the funds are not only free of tax, but do not need to be declared on a tax return.
Bond withdrawals can result in unintended tax consequences, so it is always best to speak to one of our Financial Planners before proceeding.
A Trust can be an effective way of mitigating an Inheritance Tax liability, but you should always take financial (and sometimes legal) advice to ensure it is the right course of action.
Please do not hesitate to contact a member of the team if you would like to find out more about Inheritance Tax Planning.