Inheritance Tax  

Things to know about setting up gifts and trusts

This article is part of
Guide to saving your clients IHT

Things to know about setting up gifts and trusts

Two permitted means of mitigating IHT liability are creating trusts and making provision for gifts, potentially exempt or chargeable lifetime transfers.

Martin Pickles, technical adviser for The SimplyBiz Group, explains: “Gifts can be exempt from IHT, potentially exempt, or chargeable lifetime transfers; the option chosen often coming down to the level of control the donor wishes to exert upon the recipient.

“As the former home secretary, Lord Jenkins of Hillhead, put it, IHT is ‘a voluntary tax, paid by those who distrust their heirs more than they dislike the Inland Revenue’.”

Mr Pickles continues: “It is prudent to make full use of exempt transfers, wherever possible, as the gifts out of excess income exemption are often overlooked.”

One thing to make clients aware of is, as Robert Clough, investment manager at Thesis Asset Management, points out: “Making gifts and setting up trusts both have the seven-year rule. This is where there is potential clawback on IHT if the donor dies within seven years of making the gift.”

Using trusts

Neil Jones, wealth management and tax specialist, for Canada Life, calls trusts “extremely valuable planning tools”, as, depending on individual requirements and circumstances, he says trusts allow people to:

  • Make a gift of assets while maintaining an element of control as the person can be a trustee.
  • Provide for minor children who are too young to take legal responsibility for gifted assets.
  • Mitigate or even completely reduce IHT.
  • Provide a flexible environment for the future, potentially allowing funds to skip generations.

When it comes to trusts, Alison Beech, partner at Percy Hughes & Roberts Solicitors, comments: “Putting money in a trust means certain conditions are applied and it no longer belongs to the individual who set it up.”

This is why it does not count towards IHT, as the assets belong to the trust and is therefore outside of the estate.

Ms Beech says: “A trust is an effective method of keeping control and asset protection for the beneficiary, which means a trust avoids handing over valuable assets while the beneficiaries are young.”

But while basic trusts are relatively inexpensive, there are some that are more complex to set up, needing specialist advice – and this could be prohibitive for some clients.

Some trust options are subject to their own IHT rules, while other trusts pay income and capital gains tax at higher rates, which means clients really have to understand what sort of trust they have.

Mr Pickles opines: “The use of trusts can introduce complexity. For example, the potential pitfalls of the 14-year rule, when gifts into discretionary trusts can have IHT implications beyond the usual seven-year survival period, depending upon the sequence and timing of other gifts.”

This is why he believes advice is imperative, and the adviser is in full knowledge of all other arrangements in place and possible future actions, so “there are no nasty surprises for heirs”.

Another drawback is, as Mr Clough indicates: “Tax rates on trusts aren’t particularly favourable and they can be quite expensive to establish and operate.”

Types of trust

There are various trusts, all with their own unique characteristics, outlined in detail on the HM Revenue & Customs website at https://www.gov.uk/trusts-taxes, but below is a brief summary of each one: