Two particularly common types of trust are lifetime interest-in-possession trusts – trusts created during a settlor’s lifetime that give the beneficiary the right to benefit from the trust income/property during their life, but no right to the underlying capital – and discretionary trusts.
Lifetime IIP trusts can be a particularly useful way of providing for family members, vulnerable people, or indeed settlors themselves.
Discretionary trusts are invaluable where it is desirable for the trustees to use their judgment as to who should benefit and to what extent (if at all) from a trust, depending on the beneficiaries’ circumstances.
Discretionary trusts can be particularly useful when used in a will, enabling family members most in need of financial assistance to receive it, and protecting against the risk of profligate beneficiaries squandering cash.
How are lifetime IIP/discretionary trusts taxed?
Lifetime IIP trusts (created post-March 22 2006) and discretionary trusts are subject to the ‘relevant property regime’ for IHT purposes.
This regime charges IHT at 20 per cent of the value of property settled into the trust after any exemptions and reliefs, and deduction of the IHT nil-rate band (currently £325,000).
Thereafter, an IHT charge arises every 10 years up to a maximum of 6 per cent of the value of the trust assets (‘periodic charge’), as well as a proportion of the periodic charge every time property leaves the trust (‘exit charge’).
The aim of the relevant property regime is to equalise, as far as possible, the IHT that would be payable were property to be passed on to the next generation every 30 years (an approximation for the length of a generation) on death, as compared with leaving assets in trust.
The comparison with the tax payable at 30-year intervals on the death of an individual is misleading, however, since individuals have lifetime tax planning opportunities that do not exist for trusts – for example, the ability to make potentially exempt transfers for IHT purposes.
There are also other disadvantages to bear in mind.
Relevant property trusts suffer IHT at a maximum of 38 per cent during the first 30 years of their existence – just under the 40 per cent death rate of IHT for individuals.
However, trusts do not benefit from a capital gains tax uplift on the death of a beneficiary (contrary toassets that are retained in outright ownership).
The need to raise cash to fund periodic charges and exit charges, and the administrative costs associated with reporting the liability, carry a significant opportunity cost and can be disproportionate to the size of the trust.
