Inheritance tax is a crucial consideration for those looking to pass on their wealth to future generations in the UK. With the standard rate set at 40% on estates above the tax-free threshold, it’s essential to explore strategies that can help mitigate this tax burden. One of the most effective methods is the use of inheritance tax planning trusts. A trust is a legal arrangement where one person (the settler) transfers assets to another person or group of people (the trustees) to manage for the benefit of a third party (the beneficiaries). In the context of inheritance tax planning, trusts can help in reducing the taxable value of an estate, ensuring more of your wealth is passed on to your loved ones.
Types of Trusts Used
in Inheritance Tax Planning
There are several types of trusts commonly used
in IHT planning, each with its own benefits and implications:
Bare Trusts - The beneficiaries have an absolute
right to the assets and any income they generate. These are simple and
straightforward, often used for passing on assets to minors.
Discretionary Trusts - Trustees have discretion over how
and when to distribute income or capital to the beneficiaries. These trusts are
flexible and can be tailored to meet changing circumstances, making them a
popular choice for Inheritance Tax planning.
Interest in Possession
Trusts - The
beneficiary has a legal right to the income generated by the trust assets,
though not necessarily the assets themselves. These trusts can be useful in
ensuring that a particular beneficiary receives income, while the capital
remains preserved for others.
Loan Trusts -These involve lending money to a
trust, with the loan remaining part of the settler’s estate but any growth on
the loan outside the estate. This can reduce the IHT liability while still
allowing access to the capital if needed.
Discounted Gift Trusts - These allow the settler to gift
part of their estate while retaining a regular income stream. The ‘discount’
refers to the amount of the initial gift that is considered outside the settler’s
estate for IHT purposes.
How Trusts Reduce
Inheritance Tax
When assets are transferred into a trust, they
are no longer part of the settler’s estate, provided the settler survives for
seven years after the transfer. This can significantly reduce the IHT bill on
their death. Trusts also allow for careful planning around the nil rate bands
and the use of other allowances, such as the residence nil rate band, to
further minimize tax.
Considerations and
Risks
While trusts offer valuable tax advantages,
they are not without risks and complexities. The creation of a trust involves
legal and administrative costs, and trustees must manage the trust in
compliance with tax laws, which can be complex and subject to change.
Additionally, some trusts are subject to periodic charges, such as the
ten-yearly anniversary charge, which can affect their overall tax efficiency.