Inheritance tax can come as quite a shock. The current rate is 40% for anything above £325,000. And while this might sound like a lot of cash, with average house prices around £230,000 in the UK – going up to £500,000 in London – that doesn’t leave a lot of room for anything else. However, inheritance planning can help to reduce the amount of tax that your descendants have to pay on whatever you leave behind – and one of the best ways to do that is via a trust.
Why does a trust reduce inheritance tax?
Essentially, if the trust is set up properly, the cash in it doesn’t directly belong to you anymore and this means that after it has been set up for seven years, it escapes inheritance tax charges as part of your estate. A trust is basically a legal arrangement that allows one person to hand cash or assets to someone else, to look after them on behalf of a third party. The Trustee is the person who holds the assets in trust and has the power to control them. The Beneficiary is the person for whom the trust has been set up.
What are the advantages of using a trust to reduce inheritance tax?
There are two main advantages. The first is that the cash and assets in the trust belong to the trust – not you -, which means that when it comes to calculating your inheritance tax they don’t even feature after seven years. The second advantage is that the asset can be held outside the estates of the Beneficiaries who may have their own inheritance tax planning issues. Trusts are a way of removing value from your estate without increasing the value of the estates of your Beneficiaries. An ancillary benefit of using trusts is that they can be a useful way of managing assets for someone who either isn’t old enough, or is too vulnerable, to manage these assets themselves. Trust conditions can be established that dictate how the assets in the trust should be managed and at what age the Beneficiary can be given access to them.
What are the different types of trust?
Initially, the main decision to make is what kind of trust will work best for you. Some trusts need to be set up right away but others can come into existence via a will. There are different types of taxes that apply to different trusts – for example, the Beneficiary of your trust may have to pay income tax on the payments they receive – so it’s important to choose a trust that does what you want it to. These are three of the most common structures:
Discretionary trust – this leaves all decisions about the trust to the Trustees, from how it is divided between Beneficiaries, to the investment decisions.
Bare trust – the most basic trust structure and in a sense this is not a trust at all. The assets belong to the Beneficiaries straight away but they are managed by the Trustees for their benefit.
Interest in possession trust – income from assets in the trust is made available to the Beneficiary but there is no right to the assets themselves. Often this type of trust is used by separated couples who have children from previous relationships and want to ensure that on the death of their new partner their assets will pass to their own children.
How do you set up a trust?
There are a number of key questions to answer before you can set up a trust:
- Who are the Beneficiaries to be?
- Who are the Trustees to be?
- What are the assets involved?
- What kind of trust is the most suitable?
- When do you want the trust to activate?
Once you have settled on this information then your trust is ready to be created. For further information please call 01756 799000.