Inheritance Tax (IHT) is a concern for many individuals and families across the UK, particularly those with sizable estates. One strategy that has gained traction over the years to minimise or even avoid these taxes entirely is the use of trust funds. In the following guide, we explore trust funds, offering you a robust understanding of the legal aspects and implications surrounding them and IHT.
In simple terms, IHT is a levy that is paid on an individual’s estate. This will include all property, money and possessions when they die. The tax is calculated based on the total value of your estate and becomes payable if this amount surpasses the current nil-rate band threshold of £325,000 (or in certain circumstances. £500,000). An estate valued at higher than this amount will be taxed at a rate of 40%. Depending on the size of your estate, this tax can significantly eat into the wealth that you wish to pass on to your descendants, making it imperative to plan strategically for this potential financial pitfall.
A trust fund or trust is a legal agreement that allows a third party, known as a trustee, to hold and manage assets on behalf of the trust’s beneficiaries (the parties that will receive the wealth).
There are numerous types of trusts, each with unique features and characteristics, offering flexibility in how they can be applied. From bare trusts that allow a beneficiary the right to all income and capital in the trust. To discretionary trusts that have non-fixed entitlements, each type serves different needs and objectives. Trusts are a commonly employed tool in estate planning to manage and control wealth. This offers peace of mind knowing that it will be efficiently passed onto future generations.
Trusts are not a modern invention or a financial loophole. They are a long-established and legal way to minimise IHT, backed by law. However, the legal processes involved in setting up trusts and their implications for IHT are not always straightforward, requiring a strong understanding of the UK law’s requirements.
Therefore, it is essential to seek professional advice. Mistakes in the process of setting up a trust can lead to significant legal and financial complications. And will make the whole process take more time.
Trusts can substantially reduce the taxable value of an estate. By registering assets in a trust, the assets may no longer form part of your estate for IHT purposes due to the fact they legally become the property of the trustee.
Other financial and property gifts are given by the creator of the trust. Even life insurance policies can be included in a trust after its creation to significantly reduce any tax on them.
Beyond their function of reducing Inheritance Tax, trusts also offer a host of other benefits. Such as granting greater control over when and how beneficiaries receive their inheritance and offering protection from potential creditors.
Limitations of Trusts that Should Be Considered
Despite these obvious benefits, setting up a trust should not be taken lightly. In some instances, the anticipated tax benefits may not materialise as expected. Laws can change and the ownership of assets may be disputed further down the line. Moreover, trusts themselves may be subject to their own tax regulations, which require thorough consideration. To maximise the effectiveness of an existing trust, have a legal expert assess it based on current laws, and keep up to date with any law changes that may affect the value of your estate.
Trust funds can be a powerful instrument in avoiding potentially hefty IHT liabilities. Currently, and for a long time, trusts are and have been an effective mechanism to preserve wealth. This is to ensure it is passed on to future generations in the most tax-efficient manner. However, while offering potential benefits, trusts come with their own set of challenges and intricacies. And a firm understanding of these complexities from a legal professional will help you make informed decisions about your estate planning. This can help you implement strategies that align closely with your financial objectives and the welfare of your beneficiaries.