The changes to the Inheritance Tax (IHT) treatment of unused pensions from 6 April 2027 are leading many people to consider planning options to reduce the amount of tax payable on death. Amongst the many options that can be used to mitigate an IHT liability, one of the most frequently used is to settle funds into a lifetime Trust.
A lifetime Trust can be a very powerful tool to ensure family wealth passes down between generations, at the same time reducing a potential liability to IHT.
In our experience, many people find Trusts complex, which may dissuade some from considering them as an option. In this article, we aim to answer some of the most common questions raised when discussing Trust planning with clients and outline why it is important that Trustees seek independent advice.
Are Trusts expensive to set up and run?
In most cases, there will no tax payable by the settlor when creating a Trust. Transfers up to the nil rate band (£325,000) into a lifetime Trust are not subject to an immediate charge to IHT; however, amounts exceeding the nil rate band pay an immediate 20% IHT entry charge.
Once established, Trust investments should not carry any higher annual management charge than investments held by an individual, as most major investment platforms accept Trust applications that offer the same range of investment options and features that are open to individual investment accounts.
Most lifetime Trusts will be required to submit an IHT account every 10 years after the Trust has been established. The maximum amount of IHT payable at each ten-year anniversary is 6% of the amount that exceeds the nil rate band.
What if I might need access to the funds settled into Trust?
To be effective for Inheritance Tax purposes, the settlor (i.e. the person creating the Trust) or the settlor’s spouse cannot benefit from the funds held in Trust. In other words, once the gift has been made, the funds are out of reach of the settlor. There are, however, options that provide flexibility should the settlor believe that they may need funds in the future.
One option is for the Deed to carve out a regular payment to the settlor by way of an “income”, or alternatively, the settlor can lend funds to the Trust, rather than gift them. This is less effective for IHT mitigation, as the outstanding loan remains within the settlor’s estate; however, any growth is achieved outside of the estate. A loan arrangement allows the settlor to request repayment of the loan at any time if funds are needed, for example to cover care costs.
Are Trusts difficult to administer?
Settling funds into a lifetime Trust requires the Trustees to undertake a series of steps at the outset, including formally registering the Trust with HMRC via the Trust Registration Service. Once established, Trustees will need to comply with the legislation set out in the Trustee Act and ensure that the Trust funds are invested appropriately and reviewed at regular intervals.
Where a Discretionary Trust has been established, the Trustees should also regularly review whether any of the beneficiaries require funds from the Trust. The structure of the Trust will determine whether the Trustees need to complete an annual Trust Tax Return; however, in many cases, this can be avoided by using an Investment Bond as the Trust investment vehicle.
What happens if a new grandchild or great-grandchild is born – can they benefit?
Many individuals settling funds into Trust to reduce a potential Inheritance Tax liability will select a Discretionary Trust, where a pool of beneficiaries – rather than named individuals – can benefit from the funds held in Trust. For example, a common standard wording sets out the beneficiaries as “any children, grandchildren or great-grandchildren of the settlor” and this could, therefore, easily accommodate any children yet to be born, without needing to add them as a named additional beneficiary.
Do Trusts pay a higher rate of tax than individuals?
Most Trusts do suffer higher rates of Income Tax and Capital Gains Tax (CGT). Where Trust income exceeds £500, all dividends are currently taxed at 39.35% and interest is currently charged at 45%. The impact of these punitive tax rates can, however, be reduced, depending on the type of Trust established. For most lifetime Trusts, using an Onshore Bond can defer the higher rates of tax until a chargeable event occurs, and Trustees are able to assign segments of a Bond to a beneficiary, which enables the beneficiary to encash the funds advanced at their personal rate of tax, rather than the rates applicable to Trusts.
Selecting an Investment Bond can also avoid CGT applying when investments are sold. As a Trust only receives half of the CGT allowance an individual enjoys – just £1,500 – this allowance can very quickly be used each year from a modest sized portfolio.
How do Trustees manage cash when few banks offer Trust accounts?
A common issue facing Trustees is the ability to access banking facilities. Very few banks offer accounts open to Trustees, and those that do often provide limited options and poor rates of interest. An alternative option is to place cash funds on a platform alongside an investment plan. Most platforms pay cash interest that is comparable to that offered by the few banks who do accept Trust deposits, without the difficulties Trustees face when opening an account. Furthermore, selected platforms also offer fixed term deposits and notice accounts, available to Trustees, alongside instant access options.
Why is independent advice so important for Trustees?
With many more individuals looking to protect family wealth, and reduce a potential IHT liability in the future, Trusts are an attractive option. Whilst Trustees do need to plan ahead when establishing a Trust, the ongoing maintenance of a Trust is not as onerous as some may imagine. Obtaining independent advice is, however, key to successful Trust planning, as the options open to Trustees are not as wide as those available to individuals. At FAS, we can access investment products and platforms from across the marketplace, to find the most appropriate solution for Trust applications. We can also give holistic advice on a range of other options to help protect family wealth. Speak to one of our experienced advisers to discuss further.
