Lifetime planning with trusts - introduction
Trusts for inheritance tax planning
There are many reasons why a person might want to establish a trust but a wish to reduce their liability to inheritance tax is a common one. Their aims may include:
- reducing their own liability to inheritance tax;
- ensuring that all investment growth is outside their estate;
- providing capital for beneficiaries potentially free of inheritance tax.
There are various different types of trust but for the purposes of inheritance tax planning the main ones are:
- interest in possession trusts;
- discretionary trusts; or
- bare trusts.
The beneficiaries of an interest in possession trust who are entitled to the income of the trust, are entitled to the income, net of trust expenses. The trust capital normally then passes to different beneficiaries when the life interest comes to an end.
A discretionary trust allows the settlor to provide benefits for a wide class of discretionary beneficiaries. The trustees can decide how much income and/or capital to distribute and when, to which beneficiaries payments should be made and what conditions, if any, should be attached to the payments.
The beneficiary of a bare trust has an immediate and absolute right to the capital and the income of the trust. This does not prevent the trust deed giving the trustees power to administer the trust assets as they see fit during the beneficiary's minority.
A trust can be a mixed trust where the beneficiaries have different interests in the trust property. This can be the result of the way the trust was set up or of changes, such as a beneficiary reaching their majority. Some beneficiaries might be discretionary beneficiaries, for example, and some might be the beneficiaries of a bare trust. For tax purposes, the different parts of a mixed trust are dealt with by applying the tax rules appropriate to each part.
Capital invested in the trust
The amount of the capital invested in the trust and the way it is invested will depend on:
- the settlor's means; and
- their requirement for access to the capital.
If the settlor's requires access to all or part of the capital invested in the trust a separate settlor's fund can be established within the trust or the capital can simply be lent to the trustees.
The anti-avoidance provisions that apply to parental trusts mean that a trust is not an effective way for the settlor to alienate income for the benefit of their minor children. Nor can they retain an interest in the income or capital of the trust themselves, either directly or indirectly, as the gift with a reservation of benefit provisions and the pre-owned asset regime will apply to ensure that the assets remain in the settlor's estate for tax purposes.
Additions to excluded property trusts
For the purpose of any charge under IHTA 1984 arising after the passing of Finance Act 2020, when a person is UK domiciled (or deemed domiciled), any additions to an excluded property trust, whatever the date of the additions (including additions made when the person was not UK domiciled), are not covered by the excluded property rules. For property transferred between trusts, its excluded property status depends on the current domicile of the settler (or other person) that caused the property to move to the other trust.
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