Strategies to Safeguard Family Fortune from Inheritance Tax: Unveiling the Methods Rich Families Utilize to Reduce Their Tax Liabilities
In the face of another £5 billion financial shortfall in Britain's coffers, Chancellor Rachel Reeves is turning her attention to inheritance tax (IHT) planning. As she navigates the complexities of the UK's financial landscape, it's essential for individuals to understand the various trust types available and their implications for IHT and other taxes.
Common types of trusts used in the UK for IHT planning include Bare (Absolute) Trusts, Discretionary Trusts, and Interest in Possession Trusts, each with distinct features and tax implications.
A Bare (Absolute) Trust allows the beneficiary immediate and absolute access to assets, typically at the age of 18 in England and Wales, or 16 in Scotland. Transfers into bare trusts count as gifts and may be subject to IHT if they exceed the nil rate band (£325,000 for 2023/24). Post-death, the beneficiary owns the assets outright, and income tax is paid by the beneficiary at their marginal rates (up to 45%), with capital gains tax (CGT) applying at standard rates.
Discretionary Trusts offer flexibility in asset distribution, as trustees have full discretion over distribution of income and capital among beneficiaries, who have no fixed entitlement. Subject to several IHT charges, including an initial 20% charge on transfer into trust (if above nil rate band), 6% every 10 years (periodic charge), and potential exit charges when assets leave the trust, trustees pay income tax on trust income at 45% (other income) or 39.35% (dividends), with CGT at 20% (28% for residential property gains).
Interest in Possession Trusts provide a life interest to a beneficiary, commonly a spouse, before passing capital to others. Assets transferred may be subject to IHT on settlor’s death or when the life interest ends, with periodic charges applying. Trustees pay 20% income tax on income (8.75% on dividends), with CGT at 20% (28% for residential property).
Other relevant trust types for planning include Gift Trusts (which can be bare or discretionary) and Loan Trusts, where the settlor lends money to the trust but can request capital repayment; their tax treatment depends on trust type.
Trusts can potentially mitigate IHT liability by transferring assets out of the settlor’s estate, but many transfers are still subject to IHT rules with charges applied on entry, exit, and every 10 years for discretionary trusts. Bare trusts are simpler and the assets are treated as belonging to the beneficiary for tax purposes, while discretionary trusts offer flexibility but come with heavier tax charges. Interest in possession trusts can reduce IHT by providing a life interest to a beneficiary before passing capital to others.
Establishing a trust is a popular way to beat IHT, but it's complex and comes with costs, rules, and paperwork. Every seven years, an individual can transfer up to £325,000 individually, or £650,000 from a couple, into a discretionary trust tax-free. A discounted gift trust allows the settlor to gain benefit from the trust while still making a gift into it that is inheritance tax-proof.
Matt Conradi, deputy chief executive of wealth manager Netwealth, advises that trusts can be a useful tool to help reduce inheritance tax and pass on wealth. However, the wrong set-up of a trust can lead to unexpected tax bills and administration headaches. Inheritance tax will start being levied on unspent pensions from April 2027, and around one in 20 estates are large enough to incur IHT, but this is set to rise dramatically when pensions start being counted.
As the threat of a tax raid in the autumn's Budget intensifies, many families are seeking advice on how to avoid inheritance tax due to increased anxiety. Wealth planners are receiving a flood of queries about placing wealth into trust to avoid tax. Life insurance in trust is a separate use of a trust for IHT purposes, which involves putting a life insurance policy in trust to ensure beneficiaries won't be landed with an unaffordable tax bill. A loan trust is suitable if the settlor wants to set up a trust for IHT purposes but thinks they might need the money back at some point.
In conclusion, trusts are a powerful tool for estate planning and IHT mitigation but involve complex tax rules, including potential IHT, income tax, and CGT charges. Expert specialist advice is recommended to tailor trust structures for individual circumstances.
- As the Chancellor, Rachel Reeves, explores inheritance tax (IHT) planning to address a £5 billion financial shortfall, it's crucial for individuals to grasp the various trust types available in the UK, such as Bare (Absolute) Trusts, Discretionary Trusts, and Interest in Possession Trusts.
- A Bare (Absolute) Trust, allowing immediate and absolute access to assets upon reaching a certain age, may be subject to IHT if transfers exceed the nil rate band (£325,000 for 2023/24), with income tax paid by the beneficiary and capital gains tax (CGT) applying at standard rates post-death.
- Discretionary Trusts, offering flexible asset distribution, are subject to IHT charges, including an initial 20% charge on transfer, 6% every 10 years, and potential exit charges. Income tax on trust income is paid at 45%, and CGT at 20% (28% for residential property gains).
- Interest in Possession Trusts, providing a life interest to a beneficiary before passing capital to others, can reduce IHT by mitigating taxes on income and capital. Trustees pay 20% income tax on income and CGT at 20% (28% for residential property).
- Trusts, while offering potential IHT liability mitigation, are complex and come with costs, rules, and paperwork. Households can use trusts like Loan Trusts or Gift Trusts (either bare or discretionary) to manage wealth and minimize tax burdens, but expert financial advice is indispensable for tailoring trust structures to individual circumstances.
