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Can trusts really protect your wealth from soaring Inheritance Tax costs?

Using trusts to reduce Inheritance Tax may allow you to pass more of your wealth on to your family. Learn how you can potentially use trusts for tax-planning purposes.

18/04/2023
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When planning for retirement, your main priority may be to ensure you have enough to maintain your desired lifestyle. In addition, you will likely also want to consider your family and what you can do to look after them.

Passing on your wealth to loved ones can reduce financial pressure on them and help them achieve their own goals.

However, without careful planning, they may lose some of your wealth to Inheritance Tax (IHT). In fact, according to FTAdviser, the average IHT bill could reach more than £300,000 by the 2025/2026 tax year.

Fortunately, there are ways to reduce IHT and pass on more of your estate to your family. Trusts are often used as a vehicle for passing wealth to your chosen beneficiaries and they can also be effective for mitigating an IHT bill.

However, while many people think that assets in trusts are automatically exempt from IHT, this is a common misconception. Although they can be useful for reducing IHT, there may still be tax charges involved.

Getting expert advice to understand precisely how to use trusts may help you take full advantage of their tax planning potential.

Read on to learn more about the different types of trusts and how they may be used to reduce the IHT your family has to pay.

5 of the main types of trust

When you place assets in a trust, they are held on behalf of another person, known as the “beneficiary” of the trust.

The person who legally owns the assets is known as the “trustee” and they are tasked with holding the assets for the beneficiary. When setting up the trust, you will create a trust deed, which gives instruction on how the assets should be managed.

Provided certain conditions are met, the “trustee” legally owns the assets once they are placed in the trust. This means they may not be considered part of your estate when calculating IHT.

However, this does not necessarily mean your family won’t have to pay any IHT on them at all. The amount of IHT could depend on the type of trust, the type of assets, and how long they are in the trust for.

There are several types of trusts, each with their own rules about how assets are managed and what tax is paid.

Bare trust

This is one of the most basic types of trust. Assets are held for a beneficiary who becomes entitled to them when they reach the age of 18 (16 in Scotland) provided they are mentally capable.

Interest in possession trust

Here, the beneficiary can take income from the trust right away, but does not have access to the property, cash, or investments held in the trust. This is often used by people who have remarried and want their spouse to hold assets for children from their first marriage.

Discretionary trust

The trustees have complete control over how the assets in the trust are divided among your chosen beneficiaries.

Accumulation trust

Any income accumulated by the assets is added to the total capital in the trust. In some cases, the beneficiaries can take income from the trust too.

Mixed trust

A trust that combines elements from different trusts. For example, the beneficiary may be able to generate income from an interest in possession on half of the trust fund while the other half is held as a discretionary trust.

Many of these different types of trusts may be useful for IHT planning. Choosing the right trust for your specific goals is important if you plan to use it to mitigate a potential IHT bill.

Assets in trusts may be subject to 20% IHT instead of 40%

Trusts may help you reduce the IHT that your family pays on your estate, in some cases, but this is not guaranteed and trusts can be complicated. That’s why understanding the rules surrounding IHT and trusts is crucial when deciding whether a trust is beneficial to you or not.

In some cases, your assets are subject to an IHT tax charge when you place them in a trust. Anything that exceeds the nil-rate band of £325,000 is likely to be taxed at 20%.

Additionally, assets in the trust are valued every 10 years and you may pay 6% IHT on the value of the trust over the appropriate nil-rate band(s). The amount of IHT that you pay is based on the current value of the trust. So, if you have property in a trust, for example, and the value increases, you could pay more IHT.

Finally, there may be another 6% exit charge when the trust is closed or assets are removed. Again, this is calculated based on the value of the assets at that time and is charged on a pro-rata basis since the last 10-year valuation. For example, if it has only been five years since assets were valued and you paid 6% tax on them, you could pay a 3% exit charge.

It’s also important to note that if you pass away within seven years of transferring assets into a trust, these will likely form part of your estate and could be taxed.

All this means that using a trust may reduce the IHT on your estate but, depending on how long assets are left in the trust, you and your family could still face tax charges. That’s why you may need to seek advice before using trusts to mitigate IHT on your estate.

Get in touch

If you are concerned about the IHT that your family may have to pay, we can advise you on your options – including making use of trusts. Visit our contact page or speak to your adviser.

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Benchmark Financial Planning is an Appointed Representative of Best Practice IFA Group Limited which is authorised and regulated by the Financial Conduct Authority, the registration number is 223112. Registered office: Broadlands Business Campus, Langhurst Wood Road, Horsham, West Sussex, RH12 4QP. Registered in England and Wales No 07572431.

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