Inheritance tax (IHT) is a tax that is levied on the estate of a deceased person before it is passed on to their beneficiaries Discretionary trusts are popular estate planning tools that are commonly used to distribute assets among beneficiaries in a flexible and tax-efficient manner However, it is important for individuals to understand the implications of IHT on discretionary trusts in order to make informed decisions about their estate planning strategies.
A discretionary trust is a type of trust where the trustees have discretion over how and when to distribute the trust assets to the beneficiaries Unlike other types of trusts, such as fixed interest trusts where the beneficiaries have a right to receive a specific amount of income from the trust, discretionary trusts provide more flexibility in terms of distribution.
One of the benefits of using a discretionary trust is that it can help to minimize IHT liability When assets are transferred into a discretionary trust during the settlor’s lifetime, they are considered as a gift for IHT purposes However, if the settlor survives for seven years after making the gift, the value of the assets will not be included in their estate for IHT purposes.
Furthermore, any growth in the value of the assets during the lifetime of the trust will not be subject to IHT when the assets are distributed to the beneficiaries This can provide significant tax savings over time, especially if the value of the assets appreciates significantly.
However, it is important to be aware of the IHT implications when assets are transferred into a discretionary trust on death In this case, the assets will be subject to IHT at a rate of 40% if the total value of the estate exceeds the nil-rate band, which is currently set at £325,000 Assets transferred into a discretionary trust on death are known as “relevant property” and are subject to potential IHT charges at various points during the lifetime of the trust.
One key point to note is that IHT is not payable when assets are transferred into a discretionary trust on death if they fall within the settlor’s available nil-rate band However, if the value of the assets exceeds the nil-rate band, IHT will be due on the excess at a rate of 40% iht on discretionary trusts. It is therefore important to carefully consider the potential IHT liability when setting up a discretionary trust as part of an estate planning strategy.
Another important consideration when it comes to IHT on discretionary trusts is the periodic charge that is levied every 10 years This charge is calculated based on the value of the assets in the trust at the time of the charge and is currently set at a rate of 6% for discretionary trusts If the value of the trust assets exceeds the nil-rate band, IHT will be payable on the excess at a rate of 40%.
In addition to the periodic charge, discretionary trusts are also subject to exit charges when assets are distributed to the beneficiaries These charges are designed to prevent individuals from avoiding IHT by transferring assets out of the trust without paying the appropriate tax The rate of the exit charge is currently set at a maximum of 6% for discretionary trusts, based on the value of the assets being distributed.
It is worth noting that there are various strategies that can be used to minimize the impact of IHT on discretionary trusts For example, settlors can make use of their annual exemption of £3,000 to make tax-free gifts into the trust each year In addition, the settlor can also make use of the small gifts exemption of £250 per beneficiary per tax year to make tax-free gifts into the trust.
Overall, while discretionary trusts can offer significant benefits in terms of flexibility and tax efficiency, it is important for individuals to carefully consider the IHT implications before setting up a trust By understanding the potential tax liabilities and implementing appropriate strategies to minimize them, individuals can ensure that their assets are passed on to their beneficiaries in a tax-efficient manner.
In conclusion, IHT on discretionary trusts is an important consideration for individuals who are looking to use trusts as part of their estate planning strategy By understanding the implications of IHT on discretionary trusts and implementing appropriate tax planning strategies, individuals can ensure that their assets are distributed in a tax-efficient manner while avoiding unnecessary tax liabilities.