Continuing my theme of looking at how the new inheritance tax (IHT) regime on trusts will affect the...
Continuing my theme of looking at how the new inheritance tax (IHT) regime on trusts will affect the main packaged IHT products, this month retained interest trusts are examined.
Retained interest trusts, or split trusts, are a popular plan that work by investing a lump sum into a trust that is split between a portion held on flexible trusts for the settlor's named beneficiaries and a portion reserved for the settlor absolutely.
Two versions exist, one where the portions are expressed as a percentage of the original lump sum and one where the retained portion is expressed as a fixed monetary amount.
The latter version avoids the need to do complicated calculations every time a withdrawal is taken and the settlor's estate is 'frozen' to a maximum amount equal to the retained portion, meaning that all growth is immediately outside the settlor's estate. The retained portion remains part of the settlor's estate until he has taken it out and spent it and, under the old rules, the gifted portion would be a potentially exempt transfer (Pet).
Now, the gifted portion is a chargeable transfer so as long as it, together with other chargeable transfers made in the previous seven years, does not exceed the nil-rate band, no IHT would be due on the creation of the trust. This means that if the settlor has not used this year or last year's annual exemption, up to £291,000 could be included in the gifted part before any IHT would be due. For the purposes of the 10-yearly and exit charges, the value of the fund, less any remaining value in the retained portion would be the basis for the charge.
The graph below shows how a settlor's IHT liability will reduce over time, assuming an initial lump sum of £500,000 split 50-50, and maximum withdrawals are taken over a 10-year period. The 5% withdrawal allowance is based on the whole amount that goes into the bond rather that on the retained portion.
In this example, the client builds up a nice lump sum that will be free of IHT for his heirs on his death. Under the new rules there would be a periodic charge of £12,054 on the 10th anniversary. This charge is around 2.13% of the trust fund, which is not really that significant. This could actually leave the family as a whole, a lot better off than under the old IHT rules. This is because, under the new regime, the trust fund will not form part of the beneficiaries' estate for IHT purposes. Therefore, a maximum 6% charge every 10 years will generally be better than a 40% potential charge on the death of the beneficiary.
Gifted portion of retained interest trust is now a chargeable transfer
Still an efficient way to keep overall tax charge down
Under new rules a trust fund will not form part of beneficiaries' estate for IHT purposes
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