Are trusts worthwhile now the IHT rules have changed?

two people planning financesThere are still benefits to trusts. Jennifer Russell explains the circumstances in which it’s worth considering them.

The changes to the taxation of trusts introduced by the Finance Act 2006 removed many of the inheritance tax (IHT) advantages that trusts had previously benefited from. This led some to question their ongoing relevance.

Before 22 March 2006, a lifetime gift to an interest in possession trust or an accumulation and maintenance trust was treated as a potentially exempt transfer (ie provided the settlor survived seven years, it would not affect their IHT position on death).

Since then, gifts to almost all trusts are immediately chargeable (subject to exemptions and reliefs) to IHT at 20 per cent above any available nil-rate band (currently £325,000), and up to a further 20 per cent if the settlor dies within seven years. The trust is potentially subject to IHT charges every 10 years, and when assets leave the trust.

However, trusts can still be very useful. It is worth noting that the IHT treatment of discretionary trusts and life interest trusts taking effect on death is largely unchanged. It is still possible to place assets of up to the value of the settlor’s nil-rate band into trust every seven years, or larger amounts, if the assets qualify for business property relief or agricultural property relief, without incurring an upfront IHT charge.

Giving away assets while retaining control

Unlike an outright gift, where the recipient is free to deal with the assets as they wish by placing assets into trust, the settlor can choose in the trust document who they wish to benefit, in what way and when, and can attach conditions to such benefits. If the settlor is also a trustee of a lifetime trust, they will have further control, having a say in the trust’s day-to-day running.

For those wishing to ensure that their children ultimately benefit from their estate even if their spouse remarries, a life interest trust incorporated into the will allows the survivor to occupy the home and receive income from investments during their lifetime, with assets passing to the children on the survivor’s death.

Flexibility to adapt to changing circumstances

Trusts can incorporate flexibility to allow trustees to adapt to future changes, which an outright gift would not permit.

For example, as beneficiaries’ individual circumstances may change over time, the trustees can (if they have the necessary powers) take this into account when making distributions. For example, larger distributions could be made to beneficiaries with greater need if the trustees felt this was appropriate. In certain circumstances, trusts may offer protection in the event of a beneficiary’s divorce or bankruptcy.

Protection of vulnerable beneficiaries

It may not always be prudent, or legally or practically possible, for certain intended recipients to receive a large sum outright. In cases where a person is young, lacks mental capacity or suffers from an addiction, trusts can provide valuable protection, allowing the trustees to manage funds on their behalf.

Tax planning

Although if the aim is purely to remove assets from an estate, this could be achieved by simply passing assets directly to beneficiaries. Since the introduction of the residence nil-rate band, lifetime tax planning, including the use of trusts, may perhaps be less relevant in general for home owners with descendants, but trusts can still offer tax advantages. 

For example, trusts can be used to ‘capture’ the benefit of the person’s IHT nil-rate band to avoid, in the case of an unmarried couple, the same assets being taxed on both deaths and, where a person has been widowed more than once, potentially allowing their estate to benefit from more than two nil-rate bands, as would usually be the case under the transferable nil-rate band rules. 

Trusts should not be discounted as part of an overall strategy for tax saving and family wealth protection, although this may change following the current Office of Tax Simplification review of IHT (see Gov.uk) and HMRC’s consultation on the taxation of trusts (see Gov.uk).

About the author

Jennifer Russell is an associate in the wills, trusts and tax team at Wright Hassall, and a member of The Society of Trust and Estate Practitioners (STEP).