When asked ‘are trusts exempt from inheritance tax (“IHT”)’ my answer is ‘on the whole, no, but it’s complex and you should seek advice’.
- Placing assets into a trust may attract inheritance tax.
- Trusts are typically subject to anniversary and exit charges.
- Trusts may be useful in preserving tax reliefs or for skipping generations.
Inheritance tax (“IHT”) is a wealth tax, usually (though not always) paid on death. It arises when wealth changes hands (nb. this includes ‘undervalue gifts’ as well as transfers for which there is no consideration). Gifts given, in life, up to 7 years before death, may attract IHT.
Trusts may be made either in life time or via a will. In the latter case, the trust comes into existence only on death.
For an insight into tax treatment, consider the example of a discretionary trust created in lifetime: John pays £425,000 into a discretionary trust for his grandson, IHT is payable immediately (at a rate of 20%) and is calculated thus: £425,000 – £325,000 (exemption/nil rate band) = £100,000 (the taxable amount). £100,000 x 20% = £20,000. Thus, £20,000 is payable in tax on entry to the trust. When John then dies (in the same year – for simplicity), the IHT liability (40%) – minus tax already paid – is due i.e. an additional £20,000 in tax (total tax paid £40,000). Anniversary charges (of up to 6%) and exit charges may also be payable over the life of the trust.
The above notwithstanding, there are certainly situations in which trusts may be useful for tax planing (advice should be obtained). By way of example where a settlor (the person creating the trust), wishes their wealth to be preserved across generations. It is possible for a trust to persist for 125 years, IHT is payable on transfer of wealth, so by ‘leaving’ property within the trust, transfer taxes may be avoided (though anniversary and exit charges may not).
Trusts may also be attractive where one seeks to preserve a tax relief. Business and agricultural assets may attract relief (of up to 100%) from IHT. Where a settlor wishes future generations to benefit, such assets may be left to a trust, in case e.g. future generations do not wish to operate the business, causing assets to lose their IHT relief. This situation should be treated with caution since sale of a business or associated asset before the 10 year anniversary of trust may lead to exit charges arising.
Trusts Exempt from Inheritance Tax
Certain trusts are ‘exempt’ from IHT, however, this is not the same as no IHT ‘s being paid. IHT still arises at the time of transfer to the trust and exit fees may still apply. Such trust include: Interest in possession trusts and situations in which assets are set aside for disabled or young people (minors or those aged 18-25).
Whilst this article doesn’t offer advice on tax planning, we strongly recommend that it is sought. The descriptions above are necessarily simplified and non-exhaustive. The field is complex and an integrated approach to IHT planning is important. Contact us now via www.confidencewills.co.uk for a no-obligation chat.