The easiest way to reduce your Inheritance bill is to give money away. The most basic piece of IHT planning advice is to use your annual exemption, and gift up to £3,000 per year.
For larger estates, this might not provide much of a saving. You might be concerned that your children aren’t quite ready to receive that much money, or that you would prefer to keep it out of their spouse’s hands. You could also need the funds later in life to pay for care.
While there is no single perfect solution, a combination of gifts and trusts can help you find the balance between control and IHT savings.
In this guide, we look at 5 different trusts, how they work, and how they could benefit you.
A bare trust is sometimes known as an absolute trust. When you set up a bare trust, the effect is the same as if you had made a straightforward gift. The value drops out of your estate after 7 years, and any profits on the investment are taxed as if they were the beneficiary’s own.
The trustees have the power to invest the funds and pay out income or capital to the beneficiaries. But they have no control over who receives the money and how much. It’s important to understand that you cannot change your mind about the terms of the trust.
A bare trust can be used to set assets aside for children. They would then receive full access to the money at age 18.
You don’t need to commit vast sums of money to set up a bare trust. A bare trust can be set up alongside a life policy. The trust remains inactive unless the settlor dies – at that point the policy benefits would be paid into the trust, for the absolute benefit of (usually) the settlor’s children.
A bare trust is tax-efficient, but also inflexible. There are a number of other trusts which allow the settlor to keep more control, but of course, they all have their pros and cons.
A discretionary trust is similar to a bare trust, in that it allows a settlor to pass a sum of money (or a life policy) to one or more beneficiaries.
However, a discretionary trust offers the following advantages:
- The trustees have more control, and can decide how and when to distribute money to the beneficiaries.
- You can write a letter of wishes to direct the trustees how you would like the money to be used, for example to pay for your grandchildren’s education.
- Beneficiaries can be selected from a ’class’ of individuals, for example, children, grandchildren, other family members and their children, even those who have not yet been born.
Despite being extremely flexible, discretionary trusts are taxed more heavily than other types of trust.
- If the gift is valued at over £325,000, an immediate IHT charge of 20% of the excess applies. A further 20% is due if you die within 7 years.
- Income over £1,000 is taxed at 38.1% for dividends and 45% for other types of income. This is considerably higher than the rate paid by individuals. Beneficiaries can claim back tax on income they have received from the trust.
- Capital gains of over £6,000 realised by a discretionary trust are taxed at 20% for most assets, and 28% on property.
- Periodic and exit charges may also apply. This is broadly 6% of the value over £325,000, every 10 years, or a proportionate amount when money exits the trust.
A discretionary trust can be ideal for gifts of under £325,000, or to receive the benefits of a life policy. It may also be suitable for larger gifts, although detailed advice would be required.
Gift & Loan Trust
A gift and loan trust lets you keep full control and access to your money. The catch is that the IHT benefit is very slow to materialise. This type of trust works as follows.
- Invest some money within the trust. You can decide how much of this is designated as a gift.
- Most of the investment is designated as a loan. You can claim this back at any time, usually over a number of years, and it remains in your estate.
- Any growth on the funds accumulates outside your estate.
A gift and loan trust is useful if you have a modest IHT liability and don’t want it to get any higher. There is no immediate saving. The loan element is only removed from your estate if you withdraw it and spend it. But this must be balanced with keeping enough invested to benefit from IHT-free growth.
Discounted Gift Trust (DGT)
A discounted gift trust operates in the following way:
- Gift some money into a trust.
- Take a fixed income from the trust. This cannot be stopped or changed at a later date.
- The value of the gift is immediately reduced for IHT purposes. The better your health, and the higher the income you take, the greater the saving.
- The remaining gift falls out of your estate after 7 years.
If you were planning on withdrawing around 5% of your investment per year, but are unlikely to need lump sums, a DGT can provide a great balance between access and IHT saving.
If you don’t need the income, it probably isn’t the best solution, as the income will build up in your bank account and become part of your estate again.
Another intriguing possibility is to set up your own charitable trust. As there are significant costs involved, and the requirement to meet the criteria set by the Charity Commission, it is not for everyone. But it may appeal to a high net worth investor with philanthropic aspirations.
The benefits of this are:
- Charitable gifts are immediately outside your estate for IHT purposes.
- You can control how the money is used and the causes you would like to support.
- Income and gains are free of tax.
- You can also benefit from Gift Aid on your donations (up to certain limits). If you donate shares, no capital gains tax is paid either by you or the trust.
While this does place the money out of your own, and your family’s reach, you may feel that furthering good causes is a worthy use of your money, particularly as the tax benefits are substantial.
The right option will depend on your circumstances, your wishes, and how much control or access you need to have. A strong estate plan will use a number of strategies depending on your goals and life stage.
Please do not hesitate to contact a member of the team to find out more about estate planning.