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Inheritance Tax (IHT) is levied on a person’s estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts.
The rate of IHT payable is currently 40% on death and 20% on lifetime gifts. There is a nil rate band, £325,000, below which no IHT is payable.
A new IHT main residence nil-rate band (RNRB) came into effect on 6 April 2017. The RNRB is a transferable allowance for married couples and civil partners when their main residence is passed down to a direct descendent such as children or grandchildren after their death. The RNRB is on top of the main IHT nil rate band. Any unused portion of the RNRB can be transferred to a surviving spouse or partner in a similar way to the nil rate band.
The RNRB was introduced in stages and the allowance increased to the present maximum level of £175,000 from 6 April 2020. Going forward, the allowance is set to increase in line with the Consumer Price Index. The allowance is available to the deceased person’s children or grandchildren.
There is a tapered withdrawal of the additional nil-rate band for estates with a net value of more than £2m at a withdrawal rate of £1 for every £2 over this threshold. The legislative provisions have been drafted to ensure that an estate will be entitled to the RNRB where an individual downsized to a smaller property on or after 8 July 2015. This is the date the measure was first announced.
It is important to note that, other than in the case of large gifts (above the nil rate band) no IHT is payable on gifts made or received during someone’s lifetime. Executors are required to report on the value of taxable gifts made by the deceased during the seven-year period immediately prior to their death. A reduced rate of IHT of 36% applies where 10% or more of the net value of the estate is left to charity.
For some taxpayers, it can be beneficial to put money or property in a trust. It is important to note that if you put things into a trust then, provided certain conditions are met, they no longer belong to you. This means that when you die their value normally won’t be counted when your IHT bill is worked out. However, when you set up a trust you are giving up ownership of the assets it holds. This can be a very significant move and you must have a clear reason for setting up the Trust. It should not just be about cutting the amount of IHT due on your estate although of course this can be an important driver.
A trust is an obligation that binds a trustee, an individual or a company, to deal with the assets such as cash, property or investments which form part of the trust. The person who puts assets into a trust is known as a settlor and the trust is for the benefit of one or more ‘beneficiaries’.
The trustees make decisions about how the assets in the trust are to be managed, transferred or held back for the future use of the beneficiaries. They have the same powers a person would have to buy, sell and invest their own property
Important changes were made to the inheritance trust rules from 22 March 2006 which reduced some of the effectiveness of using trusts. However, there are still advantages for many taxpayers but proper professional advice needs to be taken.
There are a number of types of trusts which are subject to different tax rules. The main types to be aware of are as follows:
- Discretionary trusts. These are the type of trusts most commonly used for IHT planning. Here, the trustees can use their own discretion to decide how the assets in the trust are distributed. For example, the trustees will have the power to make investment decisions on behalf of the trust. This type of trust could be used to leave assets to grandchildren with the trustees deciding how to divide the income and capital between the grandchildren.
- Bare trusts. This is the simplest kind of trust and gives everything to the beneficiary straight away as long as they’re over 18. Assets placed in a bare trust do not follow the usual IHT rules and are treated as potentially exempt transfers.
- Interest in possession trusts. The beneficiary can get income from the trust straight away, but doesn’t have a right to the cash, property or investments that generate that income. This is a popular trust structure used in the will of a person who remarries after divorce, but has children from the first marriage.
- Mixed trusts. These trusts combine elements of the other main types of trust. For example, a beneficiary might have an interest in possession of half of the trust fund whilst the other half may be held in a discretionary trust.
- Trusts for vulnerable beneficiaries. There are special trust rules for disabled people or children who receive special tax treatment given their specific situation.
Whilst one of the main aims or benefits of using a trust is to help reduce the amount of IHT payable this is not always the case.
There are four main situations when IHT may be due on trusts:
- when assets are transferred or settled into a trust;
- when a trust has been in existence for ten years;
- when assets are transferred out of a trust or the trust comes to an end;
- when someone dies and a trust is involved in sorting out their estate.
A trustee may have to pay an IHT charge when a trust reaches every tenth anniversary of the date the trust was set up if the trust contains certain relevant property and assets with a value above the IHT threshold.
There are also important Capital Gains Tax (CGT) implications that must be examined. CGT may be due if assets are sold, given away, exchanged or transferred if they have increased in value since being put in a trust. Most trusts have an annual CGT exempt amount of £6,150 which is half the allowance for individuals of £12,300 for 2020-21.
Trusts also offer many other important benefits such as helping to guarantee an income for your loved ones and responsibly leave assets and money for those that are too young or vulnerable.
For example, a person setting up a trust could have a clause that his children can only access the trust at age 25. The trustees are responsible to look after and manage the trust assets for the person who will ultimately benefit from the trust.
There have also been many changes to tax laws over the years and existing trusts and wills may need to be reviewed to ensure they still offer the best possible outcome. This is especially pertinent for older trusts following the introduction of the RNRB.
If you have any concerns or queries about setting up a new trust or about existing trusts, please get in touch and we can help you with the most appropriate advice.