4 months ago • 9 mins
Inheritance tax (IHT) receipts have been rising for over a decade, and the trend is set to continue according to government statistics. At the same time, the number of trusts being used is falling. Yet, family trusts remain one of the most effective estate planning tools for your clients and create opportunities for you to seamlessly advise the next generation and should not be overlooked.
The latest HMRC statistics show that IHT collected from death transfers have almost doubled over the last 10 tax years to over £5 billion. This has been fuelled largely by rising property prices and a nil rate band that has been frozen since 2009.
In November 2021, the Treasury, in response to the OTS review of IHT, confirmed that they had decided "not to proceed with the recommendations at this time".
This means the IHT planning landscape remains unchanged, and lifetime gifting remains a key part of tax-efficient family wealth preservation. Trusts have a huge part to play in this where donors also wish to retain an element of control over the gifts, and in some cases retain some form of access for themselves.
But why are clients being put off using a trust?
HMRC put the continued fall in the number of trusts down to the increase in the rate of tax on trust investments allied to the 2006 IHT changes which dragged more trusts into the world of periodic and exit charges.
The administration of trust taxation is also perceived to be complex. Trustees may need to keep accounts and file tax returns and this may incur costs. Decisions on what action to take can be based on the potential IHT savings to be made by making a gift into trust, against the ongoing tax charges on the trust together with any professional fees.
More recently, the requirement for most express trusts, whether taxable or not, to be registered with the Trust Registration Service appears to have become another barrier. While this may be an inconvenience, even if the motives behind the register are well intended, clients should not blind themselves to the wealth preservation opportunities a trust may offer. And the lack of control and flexibility of making direct gifts to their family may be something they simply aren't comfortable with at the time the gift is to be made.
Where trust solutions are recommended to mitigate IHT, the administrative tax complexities may of course be eased by using a bond as the investment wrapper.
Unlike other investment solutions, investment bonds are non-income producing. Income and gains roll up within the plan. This means there are no income or capital gains that the trustees have to report and pay tax on each year. Income tax may only be due when the policy comes to an end or withdrawals of more than the 5% cumulative allowance are taken.
And, unlike other similar investments, chargeable gains remain assessable upon the settlor during their lifetime. So the trustee rate of tax is only payable if the settlor is no longer alive.
When trustees are ready to make an appointment to the beneficiary they can assign the bond (or segments) to them without creating a chargeable event. The beneficiary then takes ownership of the bond and can surrender at an appropriate time, with any gains assessed upon them benefitting from their own allowances and tax rates.
Once a client has identified how much they wish to gift, they may not want to make an outright gift to an individual, perhaps because they think that a person is not mature enough to use the gift wisely. Or maybe they prefer the gift to be enjoyed by a group of people, such as their grandchildren, whenever born.
Different types of trust can allow them to do this while giving them an element of control over who benefits and when.
There are broadly three types of underlying trust for anyone looking to make a gift each giving differing levels of control:
The name of each of these trusts gives a clear indication as to the starting point in identifying the suitability for your client. Suffice it to say, the more control, flexibility, and discretion over who gets what and when, the more complex the tax position could become.
Investment bonds have always been a popular trust investment. Most packaged IHT solutions such as gift trusts, loan trusts, and discounted gift trusts use them as the underlying investment.
This type of plan is suitable for those clients who have identified a sum of money that they will not need access to themselves anytime in the future. Unless an absolute trust is being used, clients should be aware that any gifts above their available nil rate band will result in an immediate charge to IHT.
But this still means that a couple can jointly gift up to £650,000 during their lifetime without suffering an immediate charge. They will save themselves IHT on any future growth, and if they survive seven years they will save £260,000 in IHT in respect of the gift. Put another way, their family could be better off by £260,000 plus the growth on £650,000.
And of course, during your clients' lifetimes, the trust can be used to benefit their family (or other beneficiaries). For example, it could be used to pay for a grandchild's university education, or as a deposit for a child's first home.
Not all clients will be happy making an outright gift. They may need to retain some access to the capital or need the funds to provide them with a source of regular payments. There are alternative types of trust plan that can help these clients.
A loan trust may be suitable for a client who may face an IHT liability in the future but doesn't feel comfortable gifting their capital and never being able to access it for themselves again.
It works by the settlor lending money to the trustees rather than gifting it. The trustees invest the money for the benefit of the beneficiaries. There is no immediate IHT to pay as the right to the outstanding loan remains in the estate i.e. the value of the estate before and after the setting up of the plan is the same, so no value has been transferred. The client can ask for repayment of the loan at any time should they need access to capital or set up regular payments if they require an income.
All the investment growth is outside the estate. And each repayment reduces the value of the loan within the estate. But once the loan has been fully repaid your clients, as settlors, must not take any further payments from the trust.
Anne, 70, creates a loan trust with a loan of £100,000. The trustees invest in an investment bond and loan repayments are set at 4% a year giving her an annual 'income' of £4,000. Anne dies at age 85 and the value of her loan trust (i.e. the surrender value of the bond) at death is now £65,000.
These trusts are particularly suitable for those clients who are likely to pay IHT on their estate on death, but who rely on their capital to provide an income in retirement.
Typically this works by gifting a lump sum into trust while retaining a right to regular payments from the trustees for the rest of your client's life. The trustees invest the lump sum in an investment bond, and the regular payment requested is paid back to your client by setting up regular withdrawals from the bond. The amount gifted for IHT is effectively reduced by the value of these "retained rights". But because the right to the regular payments cease upon death they do not form part of the estate.
The discount also means that larger amounts can be given away without a lifetime IHT charge, as long as the gifted value (after discount) is less than the client's available nil rate band. Younger clients will generally get a bigger discount unless they are in poor health, when a discount could be reduced or even disallowed altogether.
Joe gifts £500,000 into a discounted gift trust and retains a right to £20,000 'income' each year. Following underwriting to determine Joe's life expectancy it is estimated that the market value of future payments Joe will receive throughout his lifetime is £200,000. This means the amount Joe has given away for IHT is £300,000. As he has not made any earlier gifts, there is no immediate IHT charge.
If Joe dies within seven years of setting up the trust, then only £300,000 (and not £500,000) would be included in his estate. Any growth would be outside his estate from day one. The potential tax saving due to the discount could therefore be up to £80,000 (£200k x 40%).
If Joe dies after seven years, then the whole £500,000 is outside his estate.
The statistics suggest that year-on-year IHT receipts may continue to rise, despite the introduction of the residence nil rate band. Lifetime planning can help to reduce a client's liability on death. As part of this, trusts remain an effective way of achieving the efficient transfer of wealth to the next generation in a controlled way.
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Any reference to legislation and tax is based on abrdn’s understanding of United Kingdom law and HM Revenue & Customs practice at the date of production. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.
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