A trust can offer significant advantages when an individual is looking at how to reduce the potential inheritance tax (IHT) that could be payable on their death and over the last 10 years many have used a discretionary trust as a suitable solution. It allows people to remove money from their estate and gives the trustees discretion as to who benefits, when they benefit and by how much.
However, IHT is not only payable when someone dies, but can also fall due when money is settled into trust, on every 10th anniversary and when any money is distributed to beneficiaries. Even if no tax charges apply, the trustees may have a responsibility to report details of the trust to HMRC. So let us look at how these changes came about and when these tax charges can apply.
As we are looking at lifetime gifting the new resident nil rate band does not apply as this is only available on death.
Relevant property regime
In the 2006 budget, the then chancellor Gordon Brown changed the IHT treatment of trusts so that most trusts effected on or after this date fall under the relevant property regime. Any non-exempt transfers into relevant property trusts are treated as a chargeable lifetime transfer.
Prior to these changes, advisers and clients had widely used flexible trusts and the gift into the trust was treated as a potentially exempt transfer. As the new rules meant that flexible trusts and discretionary trusts both fell under the relevant property regime, the use of discretionary trusts became more popular as they offer greater flexibility.
There are other trusts that can fall under the relevant property regime, but for this article we will consider discretionary trusts.
As money settled into a relevant property trust is a chargeable lifetime transfer, where the total chargeable lifetime transfers made in a rolling seven year period exceed the IHT nil rate band (NRB), currently £325,000, an entry IHT charge applies. This amounts to 20 per cent of the excess over the available NRB and falls on the trustees to pay from the trust property. For this reason many settlors will try and avoid exceeding the available NRB and keep gifts into such trusts within this limit and use the exemptions available.
Looking at an example:
- Eric settles £125,000 into a discretionary gift trust in April 2014.
- He considers settling a further £325,000 into a new discretionary gift trust in June 2016, being his NRB.
- Besides using his exemptions he has not made any other gifts.
- The total chargeable lifetime transfers in the seven year period will total £450,000 and exceeds the NRB of £325,000. The excess amount of £125,000 would be subject to a 20 per cemt tax charge, leaving the trustees with a tax bill of £25,000.
- Eric restricts the settlement to the second trust to £200,000 and therefore avoids an IHT entry charge as the total amount settled does not exceed the available NRB.
Ten yearly IHT charges
On each 10 year anniversary of the start date of the trust the trustees have a responsibility to calculate if a charge applies and whether the trust needs to be reported to HMRC. This charge is also known as a periodic charge. Read the full article.
Written by Neil Jones, technical support manager with Canada Life’s ican Technical Services Team.
Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.
