Techzone

As IHT receipts continue to rise*, it's curious that the number of trusts being used is decreasing**. Yet family trusts remain one of the most effective estate planning tools for your clients and create opportunities for you to seamlessly advise the next generation.

Recent HMRC statistics show that IHT receipts from death transfers have doubled over the last seven tax years, peaking at £4.6 billion in 2016/17. The main drivers behind this are rising property prices and investment returns and a static IHT nil rate band over the same period.

Looking ahead, the residence nil rate band will counter the tax take due to property values. But for those still facing a potential IHT bill, perhaps this is where trusts can help.

But why are fewer clients putting their trust in trusts?

Why is the use of trusts falling?

HMRC put the continued fall in the numbers of trusts down to the increase in the rate of tax on trust investments allied to the 2006 IHT changes which dragged more trusts into the world of periodic and exit charges.

The administration of trust taxation is also perceived to be complex. Trusts need to be registered with HMRC and tax returns will normally be required to report income, capital gains and IHT. But there is no need to explain to your client how to deal with these issues. Unless trustees have any skills or knowledge of this area, this worry can be passed on to an appropriate specialist. There will be professional fees of course, but the conversation with your clients is simplified. Decisions on what action to take can be based on the potential IHT savings to be made by making a gift into trust, against the ongoing tax charges on the trust together with any professional fees.

The example below demonstrates that despite the higher income and capital gains tax charges during the investment period, the total trust tax charges are still less than the cost of doing nothing at all, leaving the beneficiaries with an extra inheritance of nearly £150,000. And enough to justify paying a professional to take away the stress of having to having to understand and complete tax returns.

How to simplify trust taxation

The outcome above could be better still with the right combination of trust and investment wrapper.

Unlike other investment solutions, investment bonds are non-income producing. Income and gains roll up within the plan. This means there are no income or capital gains which the trustees have to report and pay tax on each year. Income tax may only be due when the policy comes to an end or withdrawals of more than the 5% cumulative allowance are taken.

And, unlike other similar investments, chargeable gains remain assessable upon the settlor during their lifetime. So the trustee rate of tax is only payable if the settlor is no longer alive.

When trustees are ready to make an appointment to the beneficiary they can assign the bond (or segments) to them without creating a chargeable event. The beneficiary then takes ownership of the bond and can surrender at an appropriate time, with any gains assessed upon them benefitting from their own allowances and tax rates.

Which trust

Once a client has identified how much they wish to gift, they may not want to make an outright gift to an individual, perhaps because they think that a person is not mature enough to use the gift wisely. Or maybe they prefer the gift to be enjoyed by a group of people, such as their grandchildren, whenever born.

Different types of trust can allow them to do this while giving them an element of control over who benefits and when.

There are broadly three types of underlying trust for anyone looking to make a gift each giving differing levels of control:

• Absolute trusts,
• Flexible trusts, and
• Discretionary trusts.

The name of each of these trusts gives a clear indication as to the starting point in identifying the suitability for your client. Suffice to say, the more control, flexibility and discretion over who gets what and when, the more complex the tax position could become.

Typical trust taxations

Investment bonds have always been a popular trust investment. Most packaged IHT solutions such as gift trusts, loan trusts and discounted gift trusts use them as the underlying investment

Gift Trusts

This type of plan is suitable for those clients who have identified a sum of money that they will not need access to themselves anytime in the future. Unless an absolute trust is being used, clients should be aware that any gifts above their available nil rate band will result in an immediate charge to IHT.

But this still means that a couple can jointly gift up to £650,000 during their lifetime without suffering an immediate charge. They will save themselves IHT on any future growth, and if they survive seven years they will save £260,000 in IHT in respect of the gift. Or put another way, their family could be better off by £260,000 plus the growth on £650,000.

And of course during your clients' lifetimes, the trust can be used to benefit their family (or other beneficiaries) – for example it could be used to pay for a grandchild's university education, or as a deposits for a child's first home.

Not all clients will be happy to make an outright gift. They may need to retain some access to the capital or need the funds to provide them with a source of regular payments. There are alternative types of trust plan that can help these clients.

Loan trusts

A loan trust may be suitable for a client who has recognised they potentially have an IHT issue, but don't feel comfortable gifting their capital and never being able to access it for themselves again.

It works by the settlor lending money to the trustees rather than gifting it. The trustees invest the money for the benefit of the beneficiaries. There is no immediate IHT to pay as the right to the outstanding loan remains in the estate i.e. the value of the estate before and after the setting up of the plan is the same, so no value has been transferred. The client can ask for repayment of the loan at any time should they need access to capital or set up regular payments if they require an income.

All the investment growth is outside the estate. And each repayment reduces the value of the loan within the estate. But once the loan has been fully repaid your clients, as settlors, must not take any further payments from the trust.

Discounted Gift Trusts

These trusts are particularly suitable for those clients who are likely to pay IHT on their estate on death, but who rely on their capital to provide an 'income' in retirement.

Typically this works by gifting a lump sum into trust while retaining a right to regular payments from the trustees for the rest of your client's life. The trustees invest the lump sum in an investment bond, and the regular payment requested is paid back to your client by setting up regular withdrawals from the bond. The amount gifted for IHT is effectively reduced by the value of these 'retained rights'. But because the right to the regular payments cease upon death they do not form part of the estate.

The discount also means that larger amounts can be given away without a lifetime IHT charge, as long as the gifted value (after discount) is less than the client's available nil rate band. Younger clients will generally get a bigger discount unless they are in poor health, when a discount could be reduced or even disallowed altogether.

Summary

Year on year increases on the number of estates paying IHT may slow down or even be reversed with the residence nil rate band likely to take many modest value estates out of the IHT net. But the complicated nature of these rules will mean that clients will still need advice on how to maximise this additional band. And there will be those with larger estates for whom the residence nil rate band is but a distant dream. Trusts remain an effective way of reducing IHT for both of these groups and so maximising the amount of wealth transferred to the next generation.

* HMRC inheritance tax statistics

** HMRC trusts statistics