Inheritance tax (IHT) is a tax that is levied on the estate of a deceased person before it is transferred to their beneficiaries It is a complex and often misunderstood tax that can have a significant impact on the amount of wealth passed on to loved ones However, there are ways to reduce or even eliminate the amount of IHT that is payable, and one of the most effective ways to do this is through the use of trusts.
Trusts are a legal arrangement that allows a person (the settlor) to transfer assets to another person or group of people (the trustees) to be held for the benefit of a third party (the beneficiaries) Trusts can be used for a variety of purposes, including protecting assets from creditors, providing for minor children, and of course, reducing the amount of IHT that is payable on an estate.
There are several types of trusts that can be used to avoid or reduce IHT, including:
1 Discretionary trusts: Discretionary trusts are a type of trust where the trustees have discretion over how the trust assets are distributed to the beneficiaries This flexibility can be useful in reducing IHT, as it allows the trustees to choose the most tax-efficient way to distribute the assets For example, they can take advantage of the annual IHT exemption, which allows up to £3,000 to be gifted tax-free each year.
2 Bare trusts: Bare trusts are a simple form of trust where the beneficiaries have an absolute right to both the income and capital of the trust Because the beneficiaries have a vested interest in the trust assets, they are treated as the legal owners for IHT purposes This means that the assets in a bare trust are not included in the settlor’s estate for IHT purposes, helping to reduce the overall amount of tax payable.
3 trusts to avoid iht. Life interest trusts: Life interest trusts are a type of trust where the beneficiaries have a right to the income from the trust assets for their lifetime, but do not have absolute ownership of the assets themselves This can be useful in reducing IHT, as the assets in the trust are not considered part of the beneficiaries’ estates for IHT purposes Instead, they are included in the settlor’s estate, but as the beneficiaries only have a life interest in the assets, the value of the trust is reduced for IHT purposes.
4 Potentially exempt transfers (PETs): PETs are gifts made by the settlor that are exempt from IHT if the settlor survives for seven years after making the gift If the settlor dies within seven years, the gift may be subject to IHT at a reduced rate However, if the gift is made into a trust, it can be structured in such a way that it falls outside of the settlor’s estate immediately, potentially reducing the amount of IHT payable.
Using trusts to avoid IHT can be an effective way to reduce the tax liability on an estate and ensure that as much of the wealth as possible is passed on to loved ones However, it is important to seek professional advice when setting up a trust, as the rules around trusts and IHT can be complex and the consequences of getting it wrong can be significant.
In conclusion, trusts can be a powerful tool for reducing or even eliminating the amount of IHT that is payable on an estate By using the right type of trust and structuring it correctly, it is possible to pass on wealth to loved ones tax efficiently Trusts such as discretionary trusts, bare trusts, life interest trusts, and potentially exempt transfers can all be used to help avoid IHT and ensure that more of your estate goes to those you care about.