Using Trusts to Save Inheritance Tax

Inheritance tax (IHT) is a concern for many individuals in the UK who wish to pass on their wealth to future generations.

The burden of IHT can significantly reduce the amount received by beneficiaries.

Trusts & Inheritance Tax

Trusts offer a flexible and powerful solution to protect assets, manage wealth, and potentially reduce IHT liabilities.

In the third of a four-part series of blogs we examine the use of trusts in reducing or eliminating inheritance tax.

Surely trusts are just for the very wealthy?

This is not true.

People who I speak to in the course of estate planning often tell me they find the idea of trusts scary, they don’t understand them and therefore are reluctant to consider using them.

So how does a trust work?

I try to compare them with a limited company, which is a vehicle familiar to many people.

Although different in many ways, there are similarities between companies and trusts – they are both separate entities in their own right and have their own tax rules and reporting requirements.

Trustees act in a similar way to directors, they are the people who control the assets and make decisions.

Trust beneficiaries are similar to shareholders as they own (or potentially own) the capital and may have a right to income.

Why use a trust rather than make an outright gift?

There are several benefits of using a trust:

The capital gifted into a trust has a layer of protection that does not come with making an outright gift.

This is particularly important in divorce cases and personal bankruptcy and is often used by families to avoid family wealth going outside the family, particularly where there might be family members who are young or have partners you don’t consider suitable.

Capital gains tax payable on a disposal of chargeable assets by way of gift can be deferred for assets going into a trust.

Conversely outright gifts of chargeable assets are liable for capital gains tax on the difference between market value and cost.

This is really useful if you wish to give away a residential property or shares sitting on a large capital gain, as it avoids having a large tax bill with no cash proceeds from which to pay it.

For couples will trusts can be used to transfer assets away from the surviving spouse on first death.

That can be useful for smaller estates to transfer say half the house into trust on first death, thereby ensuring that portion of the estate is not available to the council should the surviving spouse need to go into care.

Another valuable use of will trusts is for business assets.

These generally qualify for 100% business relief, but this relief could be lost if the business assets or shares are passed to the surviving spouse who then sells the business.

When they die the cash proceeds are chargeable to inheritance tax, rather than being outside the estate in a trust wrapper.

Discretionary trusts are very flexible concerning who is entitled to trust income and capital

This decision is made by the trustees from the pool of potential beneficiaries.

Where the trust has income the trustees can choose to distribute that income to beneficiaries with low tax rates.

Minor children are ideal because they typically have unused personal allowances, meaning the whole of the trust income becomes effectively tax free.

What are the disadvantages of using a trust?

Cost

There are one-off legal costs of setting up the trust.

In addition there are accountancy costs to register the trust with HMRC and possible annual reporting requirements if the trust is taxable.

Chargeable lifetime transfers

Gifts into trust are “chargeable lifetime transfers” for inheritance tax (IHT) purposes.

That means they are potentially liable to IHT at 20%.

However you can offset your nil rate band against them, so you will usually only have lifetime IHT to pay if the asset transferred is valued at more than £325,000, or £650,000 if a couple are doing the transfer.

10 year charges

Discretionary trusts are subject to 10 year charges.

Essentially on each ten year anniversary the trust fund is valued.

If the value exceeds the then nil rate band there will be a tax charge on the excess, usually at around 6%.

We would usually aim to keep the initial capital transfer into the trust below the nil rate band to minimise any IHT payable.

Is a trust right for me?

Trusts won’t be for everyone, and sometimes simple lifetime gift(s) will be the best route.

However trusts should not be overlooked as they can often be a very useful tool in your overall tax planning arrangements.

Getting in touch with us

If you would like to explore more about using trusts or your inheritance tax planning strategy contact Jan Friend by email or on 01634 731390.

Our Services

To read more about our services please see our related pages below:

Estate Planning

Reducing Tax

Blogs related to Trusts & Inheritance tax

Take a look at our other blogs on the topic of Inheritance Tax:

Inheritance tax friendly investments

Have you considered trusts for holding family investments?

The content in this blog is correct as at 31st August 2023. See terms and conditions.