Luanne Ahearne talks about the practical considerations of choosing trusts
IHT can be charged during an individual's lifetime in respect of gifts. Lifetime gifts can generally be classed into three categories; exempt, potentially exempt or a chargeable transfer.
An exempt gift is totally exempt from IHT and is where for example, a gift is made between two UK domiciled spouses/civil partners. A Potentially Exempt Transfer (PET) is where a lifetime gift is made to either an individual, a Bare Trust or a trust created for a disabled person (as defined under section 89(4) IHTA 1984). If a donor survives the PET by seven years, it will be totally outside of his/her estate for IHT purposes. A Chargeable Transfer is where an individual establishes a flexible/discretionary trust and is not immediately chargeable to IHT assuming there is an available nil rate band with which to offset it and the amount of the gift made is not in excess of that available nil rate band. Where the available nil rate band is exceeded, the excess is subject to IHT at 20%.
Where a trust is created, it is essential to understand the type of transfer which is being made in order to understand the IHT implications. Where that asset is an offshore bond, then prior to 22 March 2006, many individuals would have been using 'interest in possession' trusts which created a PET. The Finance Act 2006 confirms that for individuals now wishing to place their offshore bond under trust, the type of transfer made will depend on whether the trust is created on a bare or flexible basis.
- The creation of the trust constitutes a PET.
- If the settlor dies within seven years of the trust's creation, the value of the initial gift would become potentially chargeable to IHT unless there was an available nil rate band with which to offset against the value of the gift.
- Any growth on the value of the gift is immediately outside of the settlor's estate for inheritance tax purposes.
- The value of the trust fund will form part of the named beneficiary's estate for IHT purposes.
- The creation of the trust is a chargeable transfer.
- If the settlor died within seven years from the date the trust is created, there is no IHT payable on the value of their gift assuming there was no charge to IHT at the time the trust was created. However, it must be remembered that tax would arise if a previous PET had retrospectively become chargeable and thereby increased the settlor's cumulation to bring the chargeable transfer over the IHT nil rate band.
- Where the nil rate band was exceeded on the creation of the trust, there would be further IHT to pay on the chargeable transfer if the settlor died within the seven year period.
- If a settlor survives for seven years, the chargeable transfer drops out of his/her cumulation period.
- Any growth is immediately outside of the settlor's estate for IHT purposes.
- The trust will be assessed for IHT on every tenth anniversary and every ten years thereafter at a maximum charge of 6% on the excess of the value of the trust fund over the nil rate band.
- Distributions from the trust may trigger an IHT charge.
- There will be reporting requirements to HMRC.
Apart from considering the IHT implications of establishing a trust, it is of course necessary to be practical in terms of whether or not a client can afford to gift away large amounts of capital without further access.
A Gift Trust represents the simplest form of IHT planning in that the settlor passes property by way of a gift, to the trustees for the benefit of chosen beneficiaries. This kind of trust is most suitable for individuals who can afford to gift away capital as the settlor will be totally excluded from benefit.
The Loan Trust is suitable for clients who wish to make a gift of the growth of his or her initial investment and still retain control over it. Although the settlor is not a beneficiary, he or she is entitled to repayment of his or her loan and thus on the settlor's death, any outstanding loan will form part of their estate for IHT purposes.
A Discounted Gift Trust is a trust which allows the settlor/s to carve out a right to capital sums payable on, and contingent only upon, surviving to each successive anniversary date of the trust. The value of the amount gifted is reduced because in the case of a gift made subject to retention of a contingent interest, the amount of the transfer equals the gift less the value of the contingent interest. The trust would suit individuals who are prepared to make a gift so long as their standard of living can be maintained and who can afford to gift away any potential growth on their existing capital.
IHT planning is not just about looking ahead to the future, it is very much based on both the present and the past.
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