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Read more articles in: Author, Blog, Family, Family Law, Rachel Blackburn

How trusts protect your assets from Inheritance Tax

Inheritance Tax serves as a significant consideration for anyone engaged in estate planning.

This tax affects the estate – comprising property, money, and possessions – of someone who has passed away.

The current thresholds and rates set by the Government play a crucial role in determining how much tax the estate owes.

The current rate is 40 per cent on anything over the £325,000 threshold (known as the nil-rate band, which applies to everyone, regardless of their assets).

However, the strategic use of trusts can help you reduce your tax liabilities for the portion of your estate that exceeds this threshold.

A quick note on the nil-rate bands

On top of the £325,000 nil-rate band, if you own a home, you are also entitled to the residence nil-rate band which allows for a further increase in your threshold, based on the value of your primary residence.

This is currently £175,000.

That gives you a possible personal threshold of £500,000 before Inheritance Tax is levied against your estate.

In addition, if you pass the entirety of your estate to your spouse in your Will, your nil-rate bands are also transferred.

Combined with your spouse’s thresholds, this gives you, as a couple, the ability to pass down a total of £1 million without incurring Inheritance Tax. Anything left to spouses is fully exempt from Inheritance Tax under the spousal exemption.

The role of trusts in estate planning

A trust is a legal arrangement where trustees hold and manage assets for the benefit of beneficiaries.

Trusts used in estate planning can take various forms, including Bare Trusts, Discretionary Trusts, Interest in Possession Trusts, and Accumulation Trusts.

Each has unique characteristics that cater to different estate planning needs.

Trusts offer a way to protect assets from Inheritance Tax by separating the legal ownership (held by the trustees) from the beneficial interest (enjoyed by the beneficiaries).

Trusts can reduce Inheritance Tax liability through several mechanisms:

  • Lifetime transfers to trusts: Transferring assets into a trust during one’s lifetime can be a potentially exempt transfer, with no Inheritance Tax due if the settlor survives for seven years after making the transfer.
  • Trusts for minor children or grandchildren: These trusts allow for tax-efficient ways to pass assets to minors, providing control over the timing and manner of distribution.
  • Trusts and the nil-rate band: Each trust can benefit from its own nil-rate band in certain conditions, potentially reducing the Inheritance Tax burden on the estate.

These strategies are governed by specific sections of the Inheritance Tax Act 1984 and other relevant legislation, making it essential to understand these legal frameworks when considering trusts for estate planning.

Further considerations and limitations

The timing of transfers into trusts and the seven-year rule are crucial in potentially exempt transfers.

The legal and tax implications of transferring assets, including exit charges and periodic charges, require careful consideration.

It’s critical to recognise that while trusts offer a viable strategy for asset protection and Inheritance Tax mitigation, they are not a one-size-fits-all solution and come with their own set of challenges.

For instance, the administrative burden and costs associated with setting up and managing trusts should not be underestimated.

Trustees are also responsible for complying with a range of legal and regulatory requirements, including record-keeping, and reporting to HM Revenue & Customs, which can be complex and time-consuming.

Additionally, the tax advantages of trusts have been subject to increasing scrutiny and legislative changes, meaning the landscape in which trusts operate can evolve, potentially affecting their efficacy as a tax planning tool.

It’s also important to consider the flexibility of access to assets placed in trust, as once transferred, the settlor’s direct control over these assets diminishes, which might not suit everyone’s estate planning objectives.

As a result, we strongly encourage readers to consult with a solicitor to tailor estate planning strategies to their specific circumstances.

Personalised advice is invaluable in setting up trusts and navigating the intricacies of estate planning and Inheritance Tax mitigation.

For those looking to protect their assets and minimise their Inheritance Tax liability, reaching out for expert guidance is a crucial step towards achieving your estate planning goals.

Please contact our team for further information and guidance.

Rachel Blackburn

Head of Wills, Probate and Older Client Services

I joined Mander Hadley’s Wills, Probate and Older Client Services Team in 2018.I specialise in the preparation of Wills, Probate and estate administration, trusts and trust administration and Lasting Powers of Attorney. I also have experience of care fee planning and appeals of Continuing Health Care decisions.