In other articles, our expert team at Foxley Kingham has been looking at the different ways that individuals can mitigate the inheritance tax burden left to their family, upon their death. Lifetime trusts and inheritance tax (IHT) are intrinsically linked and could, for many, make a huge difference when it comes to mitigating IHT. Here’s all you need to know.
Start with the basics – what is a trust?
Before we can get into the detail of how it can help you lower the IHT burden, we need to understand exactly what a trust is. A trust is a legal arrangement that allows you to give your assets away indirectly. Each trust is made up of:
(a) the settlor – the person putting the assets into the trust
(b) the trustees – those responsible for managing the trust
(c) the beneficiaries – those who will benefit from the trust
To put it simply – the trust will hold assets under the management of the trustee(s) for the benefit of one or more beneficiaries.
Although trusts can be set up for several reasons, we’re going to look specifically at how they can be used to save IHT and potentially defer a capital gain.
Lifetime trusts
Setting up a trust in your lifetime allows you to pass on assets immediately, but as with all gifts made by an individual, these assets will not be completely discarded from your estate until seven years have passed.
When you gift an asset (for example, a second property) to an individual, you may incur a capital gains tax liability. This liability will be due on the uplift in value from the original purchase price to the market value at the time of the gift.
If you gift the asset into a trust this is instead classified as a chargeable lifetime transfer (CLT) and the capital gains tax charge may be eliminated by way of a claim for holdover relief – any gain on the asset is deferred until it is eventually sold. That said, due to parental settlement rules, this saving would not be applicable for trusts that are set up by a parent for their minor children.
Whilst the settlor may be able to enjoy relief against capital gains tax, if the market value of the CLT, when added to the value of any other CLTs made by the settlor in the preceding 7 years, exceeds the IHT nil rate band (currently £325,000) an immediate 20% IHT tax charge will be incurred on the excess.
This charge would fall onto the settlor, although an agreement can be made with the trustees for them to meet this liability instead. It’s also worth noting that the amount of the transfer will need to be grossed up if the settlor pays the IHT charge.
If the settlor then survives 7 years, there will be no further IHT payable on the CLT. Success!
Periodic and Exit Charges
As with most trusts, a lifetime trust may be liable to both periodic and exit charges during its existence.
On each 10-year anniversary of the trust being created, the trust is taxed on its value less the IHT nil rate band available to the trust. The tax rate on the excess is 6%. If the value of the trust is below the IHT nil rate band, then there will be no charge.
Although the calculation may sound straightforward, it can be quite complex as previous CLTs also need to be considered in the calculation.
When assets or capital (not income) are transferred out of the trust or distributed to the beneficiaries the trust may also incur an exit charge. This is taxed at a maximum of 6% depending on when within the 10-year period the transfers take place.
So what does this all mean?
The use of trusts can be both a way of controlling and protecting your family assets, providing the beneficiaries with a stable income and eventually passing the assets onto the next generations.
So long as you, as the settlor, are not benefiting from the assets once they are placed in trust they can be a way of reducing the value of your estate and lessening the IHT burden for your family.
Chris Beard, Tax Manager at Foxley Kingham said:
“Placing assets into a trust up to the value of £325,000, and in the case of joint assets, £650,000, will not incur an initial IHT charge, and has the bonus of potentially allowing you to defer your capital gains tax too. With this in mind, and if you are looking to pass on your assets to the next generation, then a trust may be the right step for you to take.
Due to the complexity, a lot of matters need to be considered when setting up a trust, in particular being aware of the ongoing administrative costs and tax requirements. But with the new UK Government’s first budget coming at the end of October we’re expecting to see potential changes to IHT and Capital Gains Tax. By acting now and with careful planning there are still tax savings to be made – it’s definitely a good time to assess your current position.”
If you’d like to speak to the team about lifetime trusts and inheritance tax, or just to get a clearer understanding of your current tax position, get in touch with the Foxley Kingham team.