Inheritance Tax  

How to pick the right trust

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Death, tax and demographics

When relevant property (and virtually all property is ‘relevant’) is transferred out of the trust, IHT is charged up to a maximum of 6 per cent on the amount transferred (an ‘exit charge’). At each 10-year anniversary, there will also be a periodic IHT charge of up to 6 per cent of the trust’s assets above the NRB. 

Loans made by trusts are not subject to exit charges, so they can be an efficient way of removing capital from a trust, particularly as a loan will also create a debt against the beneficiary’s own estate when they die. This could also help to reduce the beneficiaries’ IHT liability. Loans still count as assets for periodic charges.

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Trustees pay income tax, in the year 2016/17, at a rate of 45 per cent, or 38.1 per cent on dividends. Trustees may decide, therefore, that it is be better for the trust to invest in non-income producing assets.

However, when the trust assets consist of investment bonds, care should be taken not to fall foul of chargeable event rules by assigning bond segments in lieu of the loan (that is, for money’s worth). This could see the trustees pay up to 45 per cent in income tax without top-slicing relief. Cash loans that fall within the 5 per cent allowances would not normally be caught out by this.

The assets in a discretionary trust do not form part of beneficiaries’ estates for IHT purposes and are disregarded when calculating means-tested benefits.

Interest in possession trusts

In an interest in possession trust, a beneficiary has an immediate right to all the income produced by the trust’s assets, although another beneficiary may have rights to the capital. They are often used to provide a surviving spouse with a lifelong income while giving the children the right to the capital.

Since 2006, these trusts have largely fallen under the RPR regime. They are taxed similarly to discretionary trusts, although income tax is payable at the beneficiary’s marginal rate, rather than the rate for trustees.

Absolute (bare) trusts

These are the simplest type of trust. The settlor makes a gift into trust, which is held for a specified beneficiary or beneficiaries, usually minors. The gift is classed as a potentially exempt transfer (PET) for IHT purposes, so there is no tax to pay on entry. As long as the settlor survives for seven years, the value falls outside their estate.

However, the trust fund will form part of the beneficiary’s estate from day one. Income from trust assets is taxed against the beneficiaries. This is particularly useful if the beneficiary is a minor. If the settlor is the parent of the beneficiary, any trust income over £100 is taxed on the parent, not the beneficiary.