Inheritance Tax (IHT) is a complex area of law that affects many individuals and families when it comes to passing on their wealth to future generations One way that people try to mitigate this tax burden is by setting up discretionary trusts These trusts allow individuals to control how their assets are distributed after their death, while also potentially reducing the amount of IHT that their beneficiaries will have to pay In this article, we will explore the ins and outs of IHT on discretionary trusts.
First and foremost, it’s important to understand what a discretionary trust is A discretionary trust is a type of trust where the trustee has the discretion to decide how the trust assets are distributed among the beneficiaries The beneficiaries do not have an automatic right to receive any specific amount from the trust, unlike in a fixed trust where the beneficiaries are entitled to a specific share of the trust assets.
When assets are placed in a discretionary trust, they are considered to be “potentially exempt transfers” for IHT purposes This means that the assets are not immediately subject to IHT when they are transferred into the trust However, if the person who set up the trust (known as the settlor) dies within seven years of making the transfer, the value of the assets in the trust will be included in their estate for IHT purposes This is known as the “seven-year rule”.
In addition to the seven-year rule, there are other IHT implications to consider when it comes to discretionary trusts One of the key considerations is the periodic charge Discretionary trusts are subject to a charge every ten years on any trust assets that exceed the nil-rate band The current nil-rate band is £325,000 per trust, meaning that any assets in excess of this amount will be subject to a 6% charge every ten years This can result in a significant tax bill for the trustees and beneficiaries of the trust.
Another important IHT consideration for discretionary trusts is the exit charge iht on discretionary trusts. If assets are distributed from the trust to the beneficiaries, either during the lifetime of the settlor or after their death, an exit charge may apply The exit charge is calculated based on the value of the assets leaving the trust and can be up to 6% of the value of the assets This can be a significant cost for the beneficiaries of the trust, so it’s important to consider the potential IHT implications before making any distributions.
Despite the potential tax implications, discretionary trusts can still be a valuable estate planning tool for many individuals and families By providing flexibility and control over how assets are distributed, discretionary trusts can help to ensure that wealth is passed down to future generations in a tax-efficient manner They can also provide protection for vulnerable beneficiaries, such as those with disabilities or financial difficulties, by allowing the trustee to make decisions based on their individual circumstances.
There are also ways to mitigate the IHT burden on discretionary trusts One option is to make use of the various IHT exemptions and reliefs that are available, such as the annual gift exemption and the spouse exemption By making regular gifts to the trust within the annual limits and ensuring that assets are passed to a surviving spouse or civil partner, it may be possible to reduce the overall IHT liability on the trust.
It’s also worth considering the use of a loan trust alongside a discretionary trust With a loan trust, the settlor lends money to the trust rather than gifting assets outright This can help to reduce the value of the settlor’s estate for IHT purposes while still providing the benefits of a discretionary trust However, it’s important to seek advice from a professional advisor before setting up any kind of trust to ensure that it meets your individual needs and circumstances.
In conclusion, IHT on discretionary trusts is a complex area of law that requires careful consideration and planning While there are significant tax implications to be aware of, discretionary trusts can still be a valuable tool for estate planning and wealth preservation By understanding the rules and regulations around IHT, individuals can make informed decisions about how best to pass on their assets to future generations in a tax-efficient manner.