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Inheritance tax a new approach? Discretionary trusts

Inheritance tax a new approach? Discretionary trusts

In part 1 of this series, we raised the issue of Discretionary Trusts as lifetime planning instruments. Many people’s Will contain a trust of one sort to another, often in favour of a surviving spouse to protect the deceased’s share in the matrimonial home.  However, lifetime Discretionary Trust are a valuable tool in Inheritance Tax Planning and also a useful vehicle for protection of assets.

A Discretionary Trust is one where a wide number of beneficiaries are named but no one beneficiary has any absolute right to either income or capital in the trust.  Instead, the Trustees exercise their discretion as to who is to benefit.  This can either be done on a regular basis, such as an annual review to see which of the beneficiaries most needs to benefit at that time or alternatively a right can be granted to a beneficiary for use of the trust assets or a right to receive income for a specified period of time, which the Trustees could revoke if circumstances dictated.

Because of this, the Discretionary Trust acts as an excellent “shell” to protect assets since although beneficiaries can benefit from the trust at any time, because the Trustees retain their discretion should the beneficiary be put in a place where receipt of benefit from the trust would become disadvantages, the trust assets are protected, such as bankruptcy, receipt of means-tested benefits etc.

A Discretionary Trust can be used as a way to ensure that on a divorce, assets of the family which would otherwise be inherited directly by the divorcing person are not taking into account.  They are not completely watertight, however. The Court has regard to each party’s financial resources and is likely to ask itself what the beneficiary may reasonably expect to receive from the trust.  The Court is always likely to look the reality of the situation and so although a Discretionary Trust can provide a significant measure of protection, it is always in the Court’s inherent jurisdiction to “look through” the trust especially where a beneficiary has been receiving a benefit from it on a regular basis.

However, Discretionary Trusts still offer a greater measure of protection than a straightforward gift both against creditors’ claims and in any event for matrimonial relationship breakdown.

For Inheritance Tax purposes, the transfer of assets into a trust during the lifetime of the person creating it (known as the “Settlor”) is potentially chargeable to Inheritance Tax immediately as a “lifetime chargeable transfer”.  Provided that the value of the assets entering the trust, aggregated with any other lifetime chargeable transfers made in the 7 previous years, does not exceed the Nil-Rate Band for Inheritance Tax at the date of transfer into trust, no IHT becomes payable.  If it is above this, IHT is payable at the lifetime rate of 20% and should the Settlor die within 7 years of creating the trust, then an additional 20% Inheritance Tax is paid on the excess bringing the tax up to the death rate of 40%.

Although this seems a somewhat complicated set of calculations (and can sometimes prove so) a straightforward gift into a trust of the Nil-Rate Band can remove a significant value from the estate for Inheritance Tax.  The Nil-Rate Band currently stands of £325,000 and if this amount were to remain in the Settlor’s estate, assuming that Inheritance Tax becomes payable at 40% on the value otherwise in trust, this would equate to tax bill of £130,000, a not in significant amount to save.

As with all tax planning, there is never one rule to cover everybody and each individual’s circumstances must be looked at carefully. 

If Inheritance Tax is a concern to you, or if you are interested in leaving something to charity in your Will, please do get in touch with Alastair Liddiard.

Please note the contents of this blog are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.

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