For many families, Inheritance Tax (IHT) is a large financial burden. Charged at a rate of 40% on all assets over the value of any relevant nil rate bands, this is especially true for families with large estates.
The use of trusts to reduce or avoid inheritance tax (IHT) liability is a common and entirely legal tactic, provided it is done correctly and with the help of a legal professional. Despite this, there are misconceptions about this practice, which can dissuade individuals from engaging in the process of setting up trusts.
Estate planning is essential for those who aim to mitigate IHT, and want to pass on wealth in a tax efficient manner. In the following guide, we explain the importance of trusts and IHT in estate planning, and offer general guidance on how to go about doing so in a way that will reduce your tax liability on your estate.
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Understanding Inheritance Tax
When someone passes away, their estate must be administered either via their will, or if there is no valid will, in accordance with the rules of interstacy.
The people who should be receiving the assets from the estate (known as the beneficiaries) can receive significantly less if measures are not put in place to reduce the IHT liability.
There are some exceptions in relation to when IHT is applied. For example, transfers between spouses are exempt from IHT and unified nil rate bands can be transferable between spouses on second death.
This means that married couples are technically able to qualify for the £650,000 tax-free relief, provided that their wills are structured in a way that the whole estate is passed on to the other on first death, and they haven’t used up any of their available allowances through gifting to non-exempt beneficiaries.
Other than this, the only other way to reduce IHT liability is through strategic estate planning measures.
What Are Trust Funds? How Do They Affect Inheritance Tax?
Trust funds – or trusts – are legal structures put in place that store and assign rules about the distribution of assets once outside an individual’s own estate.
Many people use trusts to pass on their property to the next generation or their family members, setting rules about when this should be done – such as when their chosen beneficiaries come of age, or when the individual dies.
The type of trust will determine the level of discretion that the trustees (the people controlling the trust) have.
As well as helping to organise this transferral of assets, trusts can also reduce IHT liability, depending on the type of trust used. This is due to the fact that, once assets are placed in a trust, they are no longer owned by the individual, and so they are not necessarily considered when it comes to calculating IHT.
There is no limit to the amount of assets that can be placed in a trust. However, depending on the type of trust structure set up, if the value of the assets placed in the trust exceeds the nil rate band, there may be immediate tax implications.
The obvious downside to a trust is that the individual must rely on chosen trustees to manage the assets. If these trustees do not meet their obligations, this can cause losses in value and make the process of inheritance take much longer.
However, with the help of professionals, this can be avoided, and the benefits of avoiding IHT often far outweigh this lack of control.
Other Methods For Reducing Inheritance Tax
Properly structured wills and lifetime gifting can also potentially reduce an estate’s value to avoid IHT liability.
If an individual is concerned about placing all of their assets in a trust, they may plan to pass on certain assets that they want to retain while they are alive or pass them on through a will. Wills can be regularly reviewed and updated through the probate process, and can be made at any point in a person’s life.
A certain value of assets can be gifted to particular people. This must be done while the individual is still alive, and (generally speaking) will only avoid IHT if the individual lives for seven years after the gift is made. While this is beneficial in certain circumstances, placing the assets in a trust is often more reliable.
How Can You Set Up a Trust?
Setting up a trust is a complex legal process, but professional wills, trusts, estate and succession planning solicitors can make it simple. The first thing you should do is seek advice on making trusts to find out whether doing so is the best option for you, and which type of trust would be most beneficial.
You should make sure that the assets you are placing in the trust are not essential to your current ability to live, and ensure you have a plan to distribute those that are when the time comes for them to be passed on to your loved ones.
This includes situations where divorce or ownership changes may arise, causing assets to change hands or become more important than they were previously.
A professional solicitor can help with every aspect of this, from ensuring you meet your tax obligations to helping you reduce your tax liability. Do not neglect this aspect of your wealth planning, as it can significantly impact your family and loved ones.
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