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Pros and cons of onshore and offshore trusts

This article is part of
Guide to Inheritance Tax Planning

Trusts are a key vehicle used when gifting money to relatives or others in order to remove it from an individual’s estate, as they provide control to the client over how the money should be invested and the timing at which any beneficiaries receive either the income or the capital.

“They enable any subsequent growth from the date of gift to accumulate outside the settlor’s estate and ultimately the settled amount will normally fall out of the estate after seven years have expired from the date of the original gift,” adds Mr Thomson.

“Trusts have often been used for IHT planning because if you are able to get property into a trust free of inheritance tax, it may be possible to keep that property outside the reach of HMRC, possibly being able to pass them through one or more generations,” he says.

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“However, the trade-off is that with the potential IHT saving comes a loss of control and/or access to the capital.”

When setting up a trust the wording is crucial, and if the adviser is not an expert in trust wordings, he should seek separate legal advice.

Types of trust include:

• ‘Bare’. The beneficiary is absolutely entitled to the capital (the original asset) and any interest that original asset earns.

• ‘Interest in possession’. Beneficiary receives full access to all the income but they do not have any right to the capital.

• ‘Discretionary’. Trustees decide how the trust is run, how to use the trust’s income, and how the income and capital are distributed.

• ‘Accumulation’. Trustees use the income and capital to accumulate more wealth and add it to the existing capital.

Offshore trusts tend to normally be useful for advisers and trustees to give access to a wider range of investments, which will not only be insurance company funds but also unit trusts and investment trusts as well as offshore regulated funds, says Mr Thomson.

He cautions that the disadvantage of many offshore arrangements is that when the money is repatriated back to the UK by the beneficiary, a higher level of tax is payable, based on the beneficiary’s own income tax position.

In terms of factors that must be considered when using trusts in general, Mr Thompson highlights the following:

• income tax is potentially payable on trust income at 50%, although this can be reclaimed by beneficiaries who pay a lower rate of tax;

• if more than the current IHT nil rate band is gifted to a trust, there is an entry charge of 20% of the amount on the excess and potentially a 20% charge when capital is distributed;

• there is a ten year periodic charge for some trusts equating to 6% of the excess over the nil rate band; and

• legislation can and does change, so there is no guarantee that any arrangement set up now will always be effective in the future.