How trusts can protect the family assets

by | Aug 21, 2020 | Blog

Family trusts may sound rather elaborate, but they are worth considering as inheritance tax (IHT) is affecting a rising number of homeowners who may not consider themselves as wealthy.

Any assets over the nil rate band threshold for IHT, which currently stands at £325,000 for the tax year 2020/21, will be taxed at 40%. For many people, this means that their death will be the first time they become a higher-rate taxpayer.

The size of the problem has grown rapidly in the last 10 years, almost doubling what was paid previously due to the rise in the value of assets. For couples, assets passing to a surviving spouse are not subject to IHT but the future deaths of widows and widowers, as well as the impact of marriage breakdown, will mean that the number of your loved ones paying tax in the future will continue to increase significantly.

Over the years, Trusts have been used as one of the many solutions to family financial planning issues, including mitigating an IHT liability. However, in recent years the IHT treatment of Trusts has seen some of the most significant developments and legislative changes. So where does this leave families today?

How does trust work?

By setting up a trust, an agreement is made regarding the control of specific assets such as property, investments, life insurance policies, and cash.

Although trust funds are often seen as something only the very wealthy have, they have become a simple way for people who are not necessarily the highest earners to manage how assets are spent in later life.

The individual who provides the assets is known as the settlor. They decide how the trust assets should be used, and who they go to. This is usually outlined in a legally binding document called the ‘trust deed’. Sometimes the settlor also stands to benefit from trust assets, this is called a ‘settlor-interested’ trust and has its own set of special tax rules.

Trustees legally decide how assets are to be used in a trust deed. They make sure the conditions in the trust deed are fulfilled. The beneficiary, or beneficiaries, will then receive the assets to spend or use as instructed. Some parents leave money to their children to provide money for healthcare, to help them out if they’re buying a house, or to help them launch a career.

Essentially, it’s a way to ensure assets are spent wisely in case beneficiaries are deemed too young for financial responsibility, not of sound mind, or if they are incapacitated.

Trusts are also set up to pass on assets while the settlor is still alive instead of waiting to pass on an inheritance (although a ‘will trust’ can be created to pass on assets after death).

What are the different types of trust?

When planning personal finances, it is vital to consider whether the use of trusts is appropriate, and what particular type of trust is most suitable, depending on individual circumstance.

The main trusts that families are likely to consider are:

  • Bare trusts. This type of trust ensures that a specified person will benefit. From the outset, each beneficiary has a precisely defined share of the trust property that the trustees or the settlor can never change. Transfers into bare trusts are treated as potentially exempt transfer or PETs. This means if the individual survives 7 years of having made the gift, there will be no IHT due.
  • Discretionary trusts. Unlike Bare trusts, discretionary trusts are hugely flexible. The trustees have complete discretion over when they pay the trust benefits and to whom (from a wide class of beneficiaries) they make payments of income or capital. Different from the Bare trusts, transfers into discretionary trusts are treated as chargeable lifetime transfers or CLTs. This means there is an IHT charge of 20% on the amount above the settlor’s nil rate band.

What is new?

In the 2020/21 tax year, each individual is allowed to leave an estate valued up to £325,000 and take advantage of the new ‘main residence’ band of £175,000 giving a total allowance of £500,000 per person.

For estates worth less than this, beneficiaries won’t pay inheritance tax. The amount is set by the Government and is called the nil-rate band, because it’s the amount you pay a ‘nil-rate’ of IHT on.

Above that amount, anything left behind is subject to tax of 40% (or 36% if at least 10% of your assets are left to a charity).

So for example, if an individual leave behind assets in 2020/21 worth £525,000 (assuming they have just one property), the estate pays nothing on the first £500,000, and 40% on the remaining £25,000 – a total of £10,000 in tax – if they are not leaving anything to charity.

Gift giving has also changed. People can give away £3,000 worth of gifts each tax year (6 April to 5 April) without them being added to the value of their estate. This is known as ‘annual exemption’. People can carry any unused annual exemption forward to the next year – but only for one year.

With this said, anything above the £3,000 value will be charged inheritance tax (at a max of 40%). Restrictions are also in place so that an individual cannot give away more than £325,000 of gifts in the seven years before their death – so early planning of how to pass on assets is important.

As Trusts are legally-binding, it is important to ensure they are clearly laid-out. This means that the best option is to work alongside a specialist to set it up. It is not an expensive or extensive process, but the wording needs to be exact with no ambiguity.

Leah and Mike are Dunkley’s Trust specialists. They have years of experience between them, so you know you are in the best possible hands. When you come to us for support, we will work with you to determine what makes the most sense for you and your family. Despite all the changes to the inheritance taxation of trusts, clear benefits of using trusts remain for both tax and other reasons. The financial and other costs of not seeking advice in this area are simply too high to ignore.

To learn how we can help ensure your loved ones receive the full benefit of your estate, call us on 01454 619900 today.

What can we do for you?

If there’s anything you’d like to know about Dunkley’s, we’d love to hear from you.