Inheritance TaxJun 13 2019

Things to know about setting up gifts and trusts

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Things to know about setting up gifts and trusts

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:

Discretionary trust - the trustee has absolute power to decide how the assets within the trust are distributed. This option gives trustees the power to make investment decisions on behalf of the trust.

Bare trust - this method is simple, as it gives everything to the beneficiary straight away, as long as they are over the age of 18.

Interest in possession trust - the beneficiary can take income from the trust straight away, but does not have the right to the assets that generate income. However, the beneficiary will need to pay income tax on the income received. This structure is often used by individuals who have remarried following a divorce, but have children from the first marriage.

Mixed trust - combines elements from different kinds of trusts. For example, a beneficiary could be given a right to the income of half of the trust fund, while the remaining half of the trust could be held in a discretionary trust.

Gifts

Gifts are often mentioned in the same breath as trusts, but in reality they are completely different, as this denotes a certain sum given to another individual during the lifetime of the client.

Tracyann Kneen, head of product technical for Nucleus, says: “Consider gifting early where it’s practical and possible. The nil rate band is effectively renewed every seven years, enabling a fairly chunky amount of assets to pass IHT-free over a reasonable length of time.”

Clients can gift assets to a spouse or civil partner, which means the giver will not have to pay IHT – although this could just be deferring the problem, as the surviving partner will still need to put a financial plan in place to mitigate IHT when they die.

There is also the possibility of a lifetime gift to friends and relatives.

Ms Beech delineates: “By giving something to a family member or friend, the value of that gift will still be included in your estate for IHT, but only for seven years.

“For instance, if you gift a lump sum to one of your children, but live for a further seven years, the amount will not be taken into account when you die.”

Disadvantages to gifts

Sarah Saunders, personal tax manager for RSM UK, says: “Gifts offer the recipient complete freedom, so clients need to be happy they will handle your money sensibly.”

One obvious disadvantage with gifts is the client has no idea when he or she will actually die – so it pays to be judicious when recommending these to a client in obvious ill health.

Perhaps the biggest worry is that many people giving monetary gifts do not actually realise they are potentially liable, as HMRC’s recent 93-page report – Lifetime Gifting: Reliefs, Exemptions and Behaviours – has highlighted a worrying lack of knowledge about how gifts work. 

The report shows one eighth of the population gave gifts in the two years prior to the survey, and this will rise as older generations give money to their children or grandchildren to help them onto the property ladder, or assist with educational expenses.

However, while people think they are doing a good thing, the report revealed 45 per cent of the UK population is unaware of the tax implications around gifting, which can be problematic, as Rachael Griffin, tax and financial planning expert at Quilter, explains: “A lack of knowledge can be immensely detrimental.

"Gifting during a lifetime has become a perverse game of Russian roulette, thanks to potentially exempt transfers. Essentially people have to ask themselves: ‘Do you think you’ll live longer than seven years?’

“With the Office for Tax Simplification already taking a close look at IHT, it’s interesting to see that HRMC is also doing some digging.”

One of the key points is to make sure clients understand what the gift or trust means for them.Tracyann Kneen

She suggests one way to simplify things is to update the heavily outdated gifting allowance: “The annual IHT gifting allowance has remained unchanged at £3,000 since 1981 and, had the allowance been tracked to inflation, it would be permissible to gift £11,296 per tax year in 2018.”

Rhoda Copper, chartered tax adviser and council member of the Institute of Professional Willwriters, says: “If giving assets away is appropriate, then it is important to consider whether capital gains tax would apply.

“This does not apply to cash, but if a property is given to a child directly or via a trust, then it is likely any profit made between the date of acquiring that property and the date of gift will be subject to CGT.

“There are exemptions and potentially ways to defer paying the tax, but advice should be taken from a suitable professional.”

Also, when looking at the various options available for mitigating IHT, Mr Jones says the correct order of gifting needs to be considered.

“For many people, gifts to discretionary trusts should be done before gifts to bare trusts or outright gifts to individuals,” he says.

Yet he believes all available exemptions should be used. He explains: “One of the most overlooked exemptions is the normal expenditure out of income.

“As IHT is a tax on capital transfers, if there is surplus income with the intention to gift regularly then, subject to conditions, these gifts are fully exempt from day one.”

This is why Ms Kneen strongly advocates advice. She says: “One of the key points is to make sure clients understand what the gift or trust means for them. For a gift to be IHT effective, this will generally mean giving up access to the gifted assets.

“The person gifting must ensure they will have enough income and capital to live on.”

Ms Copper agrees: “One must consider their needs and financial security for the rest of their life and therefore tax savings should never be at the expense of their wellbeing.

“Everyone is different. Some people would prefer to give it all away and rely on local authority funding to provide them with their care requirements."

She adds: "However, some would prefer to fund their own long-term care, hoping to stay in control if residential care is required.”

simoney.kyriakou@ft.com

Simoney Kyriakou is currently on maternity leave