inheritance tax planning trusts

1 April 2024 

Inheritance Tax Planning Trusts In 2024

This article explains all you need to know about inheritance tax planning trusts.

What is an inheritance tax planning trust?

You can set up a trust to help you manage what will happen to your estate after you pass away. This is an important part of thinking about your estate planning and how to avoid inheritance tax.

Not only can a trust help reduce the inheritance tax you and your beneficiaries will pay, but they are also a useful tool for asset protection and to give you flexibility in how you manage your finances. However, it is worth getting advice on setting up a trust.

This is because there are complex rules about setting up such a trust, otherwise, the trust arrangement can actually leave you with more tax to pay to HMRC.

Topics that you will find covered on this page

A short video on how inheritance tax planning trusts work

Click here to see the video on youtube.

How do inheritance tax planning trusts work?

A person who establishes a trust is called the ‘settlor’. The settlor will nominate trustees, who hold the legal interest in the asset and then manage the trust on behalf of the beneficiaries.

Settlors are also often a trustee during their life. This arrangement will all be laid out in a trust deed.

For example, you could set up a trust to pay for a grandchild’s university education or for sustaining a disabled family member for life up to a certain age.

Why is less inheritance tax paid on trust property?

If you, your partner and children who are minors cannot benefit from the property and capital in the trust fund, the property is no longer considered part of your estate.

This is because technically, the assets are no longer in your hands, they belong to the trustees and beneficiaries.

This works as long as you live for over seven years after setting up the trust. If you pass away within 7 years of setting up the trust, you pay the full amount of IHT at 40%.

Here is a useful video about inheritance tax planning and trusts.

What are the different types of trust?

There are multiple types of trust you can set up when considering how to manage your estate.

When attempting to reduce inheritance tax on property and assets, most of these will have to be set up during your lifetime. It is important to do your research and get advice from legal advisers to prevent defeating the point and paying more tax.

Options include:

  • Bare trusts. This is the most basic form of trust, so one person holds the property on behalf of another, often a child. Bare trusts are often exempt transfers so you do not need to pay IHT. However, if you die under 7 years from creating the trust, tax will be charged as part of your estate.
  • Discretionary trust. This is the most common trust form. You transfer all the savings and assets to the trust, and the trustees get discretion as to how the trust is distributed between beneficiaries after your death, taking into account the settlor’s wishes. The advantage is that as the trust funds are separate, they are not charged as part of your estate.
  • Discounted gift trusts. Generally used for insurance bonds. You can get an income of up to 5% of the bond each year.
  • Interest in possession trustThis is where the beneficiary gets the income on the trust as it is generated. You may have to pay the 10-year iht charge on an interest possession trust. You also may have to pay income tax and cgt on the money you make off your investment.
  • Mixed trusts. This combines different elements of multiple types of trust, so they are specialised to your needs.
  • Trusts for a vulnerable person. This is to help manage the funds of a beneficiary who does not have the capacity to do it themself. There will generally be less tax liability on these.
  • Loan trusts. This is a form of investment where you lend out your assets to the trust. This means they still belong to you and are part of your estate. However, if you earn investments on your assets, they stay in the loan trust so when the taxman charges you property inheritance tax, the investment money is not included.

Setting up a trust fund to avoid inheritance tax

Setting up a trust fund to avoid inheritance tax is something that more and more people are looking at doing.

By transferring assets from an estate to a trust, you can set up a trust that will protect the beneficiary from inheritance tax.

As the transfer is not always considered part of the deceased’s estate, no inheritance tax will be due on these assets. A trust fund can also provide protection for your beneficiaries by ensuring that their money is managed responsibly and allocated according to their wishes after your death.

The most common type of trust used for this purpose is a discretionary trust, which gives trustees full discretion over when, how and to whom payments are made.

Trustees must adhere to any guidelines set out in the original trust document but have considerable flexibility when it comes to distributing funds to beneficiaries.

Establishing a discretionary trust offers several advantages, such as the potential for tax planning and making sure that your beneficiaries will reap future rewards.

Trusts also provide an excellent way to protect your beneficiaries’ money from creditors and divorce settlements. As the assets are owned by the trust and not by any individual, they cannot be subject to seizure or divided in a divorce settlement.

Therefore, it is important to seek professional legal advice when setting up a discretionary trust as there may be certain restrictions relating to where assets can be held and how they should be invested.

It is also essential that you review your Trust every few years as tax laws change frequently and you want to ensure that your beneficiaries continue to receive maximum benefit from the Trust.

setting up a trust fund to avoid inheritance tax

How to avoid inheritance tax with a trust?

Trusts are legal arrangements with rules and conditions that allow you to transfer assets from an individual or organisation (the ‘settlor’) to trustees (who may also be the settlor), who hold those assets for the benefit of specified beneficiaries.

When you set up a trust, you are transferring some of your wealth and possessions into the trust fund to ensure that it is not taken by HMRC when you pass away.

Establishing a trust offers unique benefits when it comes to estate planning, as you can manage and disburse your funds in the way that best suits you. Furthermore, trusts provide extensive asset protection. For example, if the settlor experiences financial hardship during their lifetime, those assets can remain safe from any creditors.

When it comes to inheritance tax relief, trusts are a useful tool as they offer exemptions on certain types of assets such as stocks and shares and land.

If you have invested in certain assets, any capital gains or income generated from them can be exempt from inheritance tax when you pass away. Moreover, setting up a trust correctly can allow for the transfer of some taxable value to your beneficiaries without incurring any taxation at all.

It is important to bear in mind, however, that there are different types of trust and each has its own rules and regulations. A specialist legal adviser can help you to select the most appropriate trust for your needs, as well as advice on how to set it up and administer it correctly in order to ensure that you maximise any inheritance tax relief available.

If you want to reduce or avoid a large Inheritance Tax bill, setting up a trust could be an effective option. With expert advice and careful planning, trusts can provide considerable advantages from both a financial and asset protection point of view.

How much is the tax on inheritance UK?

When you die, an inheritance tax bill of up to 40% on your estate value over the nil rate band can be charged.

The nil rate band is your personal allowance which inheritance tax is not charged on. It is frozen at £325,000 until 2021.

Also, if your heirs are your direct descendants, i.e. your children and grandchildren, there is an additional residence nil rate band. At the moment this is £175,000. Therefore you will not pay inheritance tax on this sum also.

Further, there is a reduced inheritance rate of 36% if the individual leaves over 10% of their possessions to charity.

For more guidance on if inheritance tax is due, the government provides up to date advice and information:

This link also provides you with the forms you need to declare your assets to be taxed:

Can you set up a trust to avoid inheritance tax?

Yes. Trusts are not tax-free, however, as they have a different tax treatment to the rest of your estate.

Therefore, they are a viable option to reduce the inheritance tax bill you and your beneficiaries have to pay, therefore preserving family wealth.

You will avoid inheritance tax liability if you set up a trust 7 years or more before your death.

Why are IHT planning trusts useful?

You may want to consider setting up a IHT planning trust because otherwise, your beneficiaries could face a very large inheritance tax bill once you pass away. This may mean they have to sell property and investments etc.

By using inheritance tax planning trusts, you can ensure that your beneficiaries inherit the shares and assets you want them to, without facing a vast tax bill.

How do you set up a trust to avoid inheritance tax?

All adults with capacity can set up a trust, and there are many companies that can help you do this.

Couples can also set up a trust together to manage how the surviving spouse can remain in the family home but still allow the value of the property to be passed onto the younger generations.

You should consult a solicitor, wealth adviser, or accountant. Setting up a trust is a complex process, and if the steps are not done correctly, you could end up paying the taxman more money.

inheritance trusts

What is a ‘spouse exemption’?

When you die, under intestacy rules, your assets can pass to a spouse or civil partner without having to pay inheritance tax IHT.

However, when they die, they will still have to pay iht. Something to consider is that if you are in a couple, you can transfer your unused nil-rate band to the spouse who dies second, which means they have double the normal nil rate band.

Do you have to pay inheritance tax on a trust?

Yes. Many people think you do not have to pay any tax to pay on a trust- this is not true. You generally pay 20% IHT if the assets are over the nil rate band.

There are exemptions to this rule, like if you continue to benefit from the trust fund assets. In addition to inheritance tax, trustees must pay income tax and capital gains tax on income from the trust assets and any chargeable gains from the trust.

How do I decide what kind of trust is right for me and my family?

It is worth seeking legal advice to help with estate planning.

However, the most common type of trust is a discretionary trust, because you can change the beneficiaries.

This is helpful to safeguard your legacy where a beneficiary goes bankrupt or has a divorce. If your trust has a particular aim and you know who you want to benefit, you may want a bare trust, so beneficiaries have a right to the trust value.

What are the inheritance tax rules on a discretionary trust?

Most trusts will be discretionary, which means the trustees get some say in how trust assets are distributed.

When you set up the trust, you pay 20% charge on the value over the nil rate band, also called your personal allowance.

At present, the personal allowance is £325,000. Then, every 10 years, you pay 6% tax on the value of money in the tax over your personal allowance. Finally, when you close the tax or remove the assets in it, you pay an exit charge of 6%.

The rate of this tax charge is based on the most recent calculation at a 10 year anniversary, calculated on a pro-rata basis.

trusts to avoid inheritance tax

How much does it cost to set up a trust to avoid inheritance tax?

It depends on the trust and the assets. On top of the 20% inheritance tax charge on assets over your personal allowance when setting up the trust, you will also have to pay legal costs.

This includes advice when establishing the trust, appointing professional trustees, and conveyancing charges whenever you transfer money in and out of the trust. It generally will cost over £1000 to set up a trust.

What is the 10 year charge on trusts?

Every 10 years, there will be a periodic tax payment on the money over the nil rate band. The maximum rate is 6%.

Interest in possession trusts will be liable to pay the 10-year inheritance tax charge.

What is the 10-year IHT charge discretionary trusts?

Trusts are not tax-free. If you have a discretionary trust, every 10 years you will have to pay a charge on the money in the trust in excess of £325,000. This charge at the moment is 6%.

What are the other ways I can avoid inheritance tax?

There are other legal ways to give money to beneficiaries and avoid paying IHT.

These include:

  • You can give a gift of up to £3000 and not face inheritance tax
  • You can give however many people you want £250 each
  • You can give your children £5000 as a wedding gift. Grandparents can give £2500. Anyone can gift £1000 in cash.
  • You can give as much as you want to charity or political parties
  • Other tax-free gits can be made, but they only fall outside your estate if you live seven years after you made the transfers. If you die within 7 years, and you have made gifts that are over the nil-rate band, then there will still be some tax relief. The tax reduces if the transfer was made 3-7 years before your death.
  • Through your pension. If you pass away before 75, then any retirement income left in a pension fund passes to your beneficiaries without you having to pay any tax on your retirement fund. If you are over 75, the inheritance will be taxed according to the beneficiaries’ marginal income tax band.
  • Life assurance can be used to pay an IHT bill.
inheritance tax trusts

Why would I set up a trust rather than making a gift to my children or grandchildren?

First, you can only make gifts of up to 3000 to children before there are tax consequences. Second, setting up a trust gives you more control as the settlor.

When you make a gift, you lose control over the assets, which is a problem if you are making a gift to someone under age 18 or if the beneficiary later gets a divorce or files for bankruptcy. If this happens, the assets will be used to pay their debts.

On the other hand, when you set up a trust, you choose your beneficiaries and as the settlor, you are likely to make yourself a trustee. You can select the beneficiaries and write a ‘letter of wishes’ for when you pass away.

How do I get legal advice to set up a trust?

Many lawyers and accountancy firms offer specialist knowledge to help you set up a trust. You may want to appoint the same solicitor as will handle your will and probate.

Jane Parkinson

Jane Parkinson

Jane is one of our primary content writers and specialises in elder care. She has a degree in English language and literature from Manchester University and has been writing and reviewing products for a number of years.

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