Inheritance Tax (IHT) could be considered a 'voluntary' tax - give away assets, live seven more years, assets outside your estate for IHT purposes….except it is usually not as simple as that. Giving away assets also means giving away the income from that asset and losing control over that asset. Where a gift of property is concerned, an outright gift may also crystallise a capital gains tax charge.
In this article you will find three types of trust which might be a suitable alternative to outright gifts in some circumstances. Note that, whilst important, the income tax treatment of trusts is not being discussed.
These are useful for gifts of property as any capital gain can be 'held over', thus avoiding crystallising a 'dry' capital gains tax charge.
However, there is a lifetime IHT charge at 20% if the value of the asset transferred exceeds the available IHT nil rate band of £325,000. A married couple/civil partnership can jointly gift £650,000, and after seven years, the IHT' clock' is reset to zero, so a further £650,000 can be given away at that time, and so on.
Typically, a family trust is set up with parents as the settlors and also trustees who therefore have control of the trust's assets and decide how to appoint out income and capital.
The trust is liable to IHT at each ten year anniversary if the value of the trust's assets at that date are above the available IHT nil rate band at a maximum rate of 6%.
A VPT is a discretionary trust, but there is no lifetime IHT charge if the value of the gift exceeds £325,000. Gifts to a VPT are treated as lifetime gifts, so the 'seven-year rule' applies.
It is vital to check whether or not the vulnerable person qualifies under these provisions as it can make a significant difference to the tax charges of both the trust and the disabled person.
There are no ten-year charges on a VPT – instead, the trust assets are treated as assets of the vulnerable person's estate for IHT purposes.
DGTs are widely marketed by life assurance companies and offer a 'halfway house' where an individual wants to give assets away to save IHT but still requires some level of income from the assets gifted.
The basic principle is that the individual (as the settlor) gifts an amount into trust -usually cash - whilst retaining a right to fixed, regular payments for the remainder of their lifetime. The value of the settlor's gift for IHT will be discounted by the estimated value of these future retained payments. For example, a 63-year-old in good health, invests £200,000 and requires income of 5% per annum; the initial discount might be £110,000, leaving a gift of £90,000. This would mean that £110,000 would be outside the estate immediately, and the £90,000 would be after seven years.
If you have any questions about IHT planning or this article or any of the topics covered, please contact us.
