Likely, you’re really searching for answers to the bigger questions ‘how can I save Inheritance Tax?’ and ‘’can Trusts help with that?’ Well, ‘easily’ and ‘maybe, but there may be better solutions’, are the quick answers
Let’s start with Trusts and work our way through to the ‘better solutions’
What is a Trust?
In its simplest form, a Trust is an arrangement in which somebody is given legal title to an asset and trusted to hold the asset(s) on behalf of the beneficiaries
Trusts were first created around 800 years ago, at the time of the Crusades, and are the original and oldest structures available for legitimate tax and associated planning
Technical Trust terms for everyone to understand
The Settlor is the person who transfers the asset(s) into the Trust. In a real world example, that’s likely Mum or Dad
The Beneficiaries are the people on whose behalf the Trust assets are held, likely the children
The Trustee(s) is the person trusted to hold the asset. That might be Mum or Dad, or a professional Trustee
The key consideration is that the Settlor (Mum or Dad) cannot be a beneficiary (must not be able to benefit) or the Trust will fail for Inheritance Tax planning purposes. Worse, there could be some Capital Gains Tax issues as well
What types of Trust are there?
Let’s keep it simple, as this part’s heavy going..
For Inheritance Tax planning purposes there are really only two types, ‘Interest in Possession Trusts’ and ‘Discretionary Trusts’
Where a named individual is beneficially entitled, for a fixed period of time, to income or enjoyment of an asset within a Trust, that person has an ‘Interest in Possession’
A Discretionary Trust is broadly any Trust where no person is entitled to an Interest in Possession
What types of Trust might be useful in Inheritance Tax planning?
Let’s start with the jewel in the crown, the Relevant Property Trust
A Relevant Property Trust is effectively treated as a separate person for Inheritance Tax purposes, which means that there is the opportunity to shelter assets outside of your estate
It is possible to create a Relevant Property Trust during your lifetime, and when you die
During your lifetime, you can transfer assets up to the Inheritance Tax nil-rate-band (£325,000 for individuals, £650,000 for married couples or civil partners) every 7 years, and free from Inheritance Tax (and from Capital Gains Tax (CGT)!)
There are ‘anniversary’ and ‘ten-year charges’ to consider but, typically, those are far less than the Inheritance Tax savings
More benefits of Relevant Property Trusts
Both the anniversary, and ten-year charges, are easily dealt with by a skilled tax professional
You can retain control over the assets
Your beneficiaries can have income from the trust, or ‘enjoyment of Trust assets’, while capital remains in the Trust. That may help with a future marriage breakdown for example
As Relevant Property Trust assets are not within anyone’s estate, it means they are not subject to Inheritance Tax in the unlikely event your beneficiaries pre-decease you
It could be a way of passing assets to, say, your grandchildren, if you want to skip a generation
Downsides of other types of Trusts
After you’ve maximised your gifts into Relevant Property Trusts, then any additional gifts into Trust are immediately chargeable to Inheritance Tax, at the ‘Lifetime Rate’ of 20%
Maybe you take the view that 20% is better than 40% (but 0% is best of all, keep reading!)
If you die within 7 years of that gift, the 20% that’s already been paid, is supplemented by a further 20%, bringing the total charged, to the standard 40% Inheritance Tax
Likely, the only reason to take this course of action is a desire to retain control over Trust assets
Typically, younger family members are beneficiaries of the Trust, but the Trust assets are controlled by the Trustees, who are usually older family members
Basic Trusts no longer achieve as much
Since March 2006, Trusts are nowhere near as effective as they once were for Inheritance Tax planning
Up to then, it was possible to transfer unlimited amounts into a Lifetime Trust, without triggering an immediate Inheritance Tax charge
Now, as we’ve seen, there’s a Lifetime Inheritance Tax charge of 20%, levied on transfer of assets to a Relevant Property Trust, to the extent the gift exceeds the donor’s current unused nil-rate-band of £325,000
So, what else may be done?
Alternatives to Trust structures
Well, Family Investment Companies were designed to produce similar outcomes, but without the same tax treatment
While not quite providing the flexibility of Trusts, their structure does separate control from ownership, and that’s key in Inheritance Tax planning
Let’s take a look at creating a (properly structured) company instead
Family Investment Companies and Inheritance Tax planning
In reality, it’s nothing more than a company which is set up to hold assets. Those assets are, typically, any type of investment and rental properties
Here’s one of the many possibilities to establish a Family Investment Company
Start by setting up NewCo with, say, £100 share capital, then transfer shares to your (adult) children
Then, transfer your properties to NewCo for an interest-free loan account, payable on demand. The importance of the loan account is you receive full consideration for the transfer, which means no transfer of value has taken place, which means no Inheritance Tax charges can arise
However, there’s a big but, read on..
Family Investment Companies and Capital Gains Tax
While the transaction just described is free from Inheritance Tax, it is treated as a sale at market value for both Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT)
The major downside with this strategy might be the up-front tax costs, which must be paid
On the other hand, you could retain control, and the repayment of the loan account could be used as a tax-free ‘income stream’. Company profits are subject to Corporation Tax at 25%, not Income Tax of up to 45%
There are plenty of planning variations using Family Investment Companies and a skilled tax advisor likely can achieve a tax-efficient solution to most any legacy planning objective.
There’s also plenty of anti-avoidance legislation to take into account!
Let’s look at a couple of examples
Family Investment Companies and structured planning
If the goal is reduction in the value of the estate of the founders of the Family Investment Company, then maybe consider gifting shares (or cash) to your grandchildren. Those gifts are unlimited, and are completely outside of the scope of Inheritance Tax provided you survive for 7 years
Where the gift is in the form of shares, it’s likely there’s merit in considering the value of ‘minority holdings’ for transfer purposes
Family Investment Companies and divorce
The main objective of legacy planning is to protect wealth for the next generation of your family
A Family Investment Company cannot stop a family member getting divorced, but the Articles of Association can be drafted to restrict transfers of shareholdings, and to include compulsory transfer provisions, which can set the value of the shares and, if appropriate, reflect a discount for a Minority Interest
An appropriate Trust holding shares might provide another layer of protection
Be aware that when a shareholder divorces, the court will take into account all their financial resources to determine the appropriate financial settlement
Be sure to take appropriate legal advice, and specialist tax advice
Why not just give it away?
Assets can be passed to other individuals as ‘Potentially Exempt Transfers’ and all you need to do is live for 7 years afterwards, then there’s no Inheritance Tax
It’s simple, it’s effective and, in the right circumstances, it may be a good thing to do
Gifts of money are most efficient. If you gift shares or property, Capital Gains Tax (CGT) will be payable on any increase in value since you acquired them
How to get your Inheritance Tax planning sorted and keep it up to date
The UK has one of the most complex tax structures in the world, with around 18,000 pages of tax laws, and nearly 1,000 tax reliefs and allowances. You can’t know them all. That’s a job for our team of Chartered Tax Advisors (CTA’s)
At outset, we ask you to visualise the future you want for your family legacy then, with our help, work back to today, using informed choices. Our CTA’s provide you with your legacy planning strategy, and all the tools you need to realise your vision
Once your Inheritance Tax planning is finalised, and paid for, you may be invited to become a full member of our Resource Optimisation Program (ROP) where our CTA’s will continue to work with you to aim to maintain everything for you while you’re alive, and they’ll even handle probate for your beneficiaries when you die, if that’s what you want..
ROP provides you with 3 options: our CTA’s will implement, maintain and manage everything, or our CTA’s will work with your existing advisors, or you can do it all yourself. That’s ‘Done for you’, ‘Done with you’ or ‘Done by you’
Contact us HERE to talk to an expert, for FREE!
