21.06.24

Life has a tendency to take over, but it is important to make time to consider the importance of securing your legacy and ensuring your family and loved ones are taken care of. Inheritance Tax (IHT) planning using Trusts can play an important, and effective, part in this as they offer a flexible solution to protect assets, manage wealth, and potentially reduce IHT liabilities.

This piece focuses on how a Trust can benefit you in terms of various Inheritance Tax considerations.

What is Inheritance Tax (IHT)?

IHT is a tax which is liable on your death estate (your worldwide property, savings, investments and other assets held at the time of death). It is most commonly payable by those that inherit from your estate after you die with the exception of your spouse. Typically, the IHT bill must be settled before the assets can be distributed.

IHT is only payable on estates above a certain amount and there are many ways to minimise or even eliminate this tax if you plan in advance and make use of all the available allowances and exemptions.

Against the value of the estate each individual is entitled to a nil rate band (NRB), the IHT threshold, which allows you to pass on your assets tax-free. This is a threshold determined by the Government. It is currently set at £325,000 and is scheduled to remain fixed at this amount until April 2028.

In addition to this, a residence nil rate band (RNRB) may be available, which gives a further relief of £175,000, which is also scheduled to remain fixed April 2028.

If the NRB or RNRB are not utilised, it may be possible for the surviving spouse to utilise these on their subsequent death.

Any part of the estate that exceeds the thresholds is generally taxed at 40%, but a reduced rate of 36% can apply, if there are charitable legacies.

Using a Trust to mitigate IHT

The NRB has remained at £325,000 since 2009, however, assets have continued to grow in value, which means that the proportion of estates now falling into the taxable bracket are increasing.

A key way to reduce your estate’s IHT liability is to make gifts during your lifetime. However, this does mean passing across the assets absolutely and you can no longer benefit from them.

A Trust gives you a level of control and flexibility over who benefits and when, rather than making an outright gift which may or may not be utilised in the way you intended.

In the simplest form a Trust is a legal agreement that moves assets e.g. property, investments and money, from your direct ownership to that of the Trustees with the ultimate aim of the assets (and the income generated) to pass to someone else (the Beneficiaries), as outlined in the Trust deed. In the meantime, the Trustees will have control and management of the assets per the terms of the Trust deed.

Seven years after the assets are put into the Trust they fall outside your estate for IHT purposes, and the value of any growth of the assets inside the Trust is also immediately outside of your estate. After seven years has elapsed you could also make further additions to the Trust up to £325,000. If desired, spouses can both do this to increase the assets transferred.

It is important to note that if you initially put assets into the Trust worth more than £325,000, the value of the assets above that amount incurs an immediate IHT lifetime tax charge of 20%.

In addition to the IHT charge there may be a charge to Capital Gains Tax (CGT) if you transfer chargeable assets into Trust but it may be possible to mitigate this charge by either transferring assets that benefit from a CGT exemption, e.g. cash, or where it is possible to defer the gain to a later date via a hold-over election.

Taxation of Relevant Property Trusts (after creation)

In addition to the potential IHT charge on creation of the Trust, there is a further IHT charge on every 10^th anniversary of the Trust but only if the assets in the Trust exceed the NRB. This charge is a maximum of 6% on the value of the Trust on the 10^th anniversary in excess of the NRB. Assuming the Trust grows to £500,000 and the full NRB is still available, this would trigger an IHT liability of £10,500 (£500,000-£325,000 @ 6%).

Each 10-year period is divided into 40 quarters. If assets are removed from the Trust (distribution made to the Beneficiaries) a potential exit charge is levied. This is based upon the same calculation made at each 10^th anniversary but pro-rated to the number of full quarters the assets remained in the Trust. For example, if only 5 years have lapsed the rate applicable would be a maximum of 3%.

Had these assets remained in the estate they would have been taxable at the full rate of 40% instead.

Summary

An IHT charge of 40% will be levied on your estate if value of your assets exceed the allowable bands. You could transfer assets to a Trust in your lifetime to reduce the IHT liability on your death as long as you are happy that you will not be able to benefit yourself.

A transfer to a Trust of up to £325,000 would be tax free and fall outside your estate after seven years. After this period of time you could put in further assets worth another £325,000 in the same way.  So, a married couple or civil partners could put in assets worth £650,000 every seven years without an immediate charge to IHT.

Trusts also pay a reduced rate of IHT of up to 6% on the value of assets exceeding £325,000 every 10 years, but this is much less than the 40% that might be paid on assets if left in your estate.

When you die, IHT and probate fees have to be paid before probate is granted and your assets are distributed in accordance to your Will. The money in your estate cannot be used until probate is granted, meaning that the executors have to use other money. However, if you have assets in a Trust that is separate from your estate, the Trustees could immediately access the money in it without having to wait for probate and pay the IHT and probate fees. This means that your family could benefit from the Trust in the meantime, whilst they wait for the estate to be concluded.

How we can help?

Calculating the value of an estate and the related Inheritance Tax bill is complex because they depend on a great many factors, including available exemptions, current legislation and who the beneficiaries are.

The rules, regulations and possibilities surrounding Trusts can also be very complex. It is therefore important to seek professional advice and guidance to ensure the correct Trust is set up for your circumstances to ensure not only the correct paperwork is drawn up but that the Trust itself meets your requirements – after all, you need the peace of mind that your family wealth is protected.

If you are interested in setting up a Trust, please do get in touch and we can assist you in determining the right structure for you alongside other estate and IHT strategies to help meet your overall goals and objectives.