4 May 2016
Author: Stephen Breen
Recently the papers have been talking about various methods that politicians have been using to ensure they pay as little inheritance tax as possible. Former Prime Minister Tony Blair used an ‘interest in possession’ trust to handle part of his estate – while Chancellor George Osborne admitted that he was a ‘life tenant’ of a family trust that pays him income.
This type of tax planning is perfectly within the law and worth considering if there is any possibility that your estate might attract inheritance tax on your death.
A trust is a legal mechanism that can help you pass on your wealth to your descendants and minimise the amount of inheritance tax paid.
As you may be aware, you can gift as much of your property as you like before your death and provide that you survive for seven years, no inheritance tax will be payable on its value.
Should you die less than three years after making a gift, inheritance tax will still be due at 40% on the gift’s value. If you die within three and seven years, inheritance tax is tapered: from three to four years, the gift is taxed at 32%, decreasing to 24% after four to five years, 16% after five to six years and 8% after six to seven years.
On your death, anything you own worth over £325,000 will be subject to inheritance tax at 40%.
Gifting your property before death can therefore seem like a good way to avoid inheritance tax. However, if you intend to leave property to your children, you may have concerns that the money could be spent before they reach a responsible age. You may also change your mind before you die about who you want to benefit – for example, if the marriage of one of your adult children should break down, you might not want the gift to be split as part of the divorce settlement.
A good way to deal with these problems is to use a trust which allows you to make a gift while retaining some control over your property. There are various types of trust that can be made and you should seek expert advice on which is suitable for what you would like to achieve.
Interest in possession trusts
Interest in possession trusts (sometimes called life interest trusts) are set up to provide a beneficiary (known as a ‘life tenant’) with the right to receive income from the trust, without being able to sell the assets it contains. This right is often for their lifetime, so that on their death the trust fund passes to ‘residuary beneficiaries’. You can establish an interest in possession trust using a trust deed or in your will.
If there is property in the trust, the life tenant may receive rental income from it, or live in it. If they choose to live in it, they would also be able to exchange it for another property, with the trustees’ permission.
This type of trust is often used in the case of second marriages. It allows you to provide for your new husband or wife but ensure the children of your first marriage ultimately inherit your property. Some people also use an interest in possession trust to help ring fence their assets so they are not substantially used up on care home fees in the future.
Discretionary trusts are also worth considering, if you would like to have more control over your assets and would like the flexibility to distribute to any of a number of people, where the need arises. This type of trust can also be set up either by trust deed or in your will.
A discretionary trust allows a class of people to benefit from your assets – for example, your children. The trustees have discretion to distribute income and assets from the trust as they see fit. You can set out how you would like the funds used in a letter of wishes, but it is not legally binding. However, you can elect to be a trustee yourself, allowing you to control distribution of income and assets during your lifetime.
A bare trust is a very simple trust where the beneficiary would, ordinarily, be entitled to both the capital and income from the trust. However, if the beneficiary is a child, they would not have access to the funds until reaching the age of 16 in Scotland or 18 in England and Wales. Until that point, any income that the trust makes is set against the child’s personal allowance which is the same as an adult’s.
One thing to note is that if you pay money into a bare trust for a child and the income exceeds £100 per year, it will be taxed at the highest tax rate of the parent making the gift. This applies even though you are not withdrawing the money from the trust. However, if a grandparent or another family member gifts as part of a bare trust, this rule does not apply to them.
How to set up a trust
Get in touch with our later life planning team who can advise you on the best way to set up a trust that is suitable for your needs. We will also be able to advise you on the inheritance tax implications for the different types of trust.