Inheritance tax is widely loathed. It’s a tax on death, property and the natural desire to pass wealth down the generations.
Anxiety among families who already hated the idea of loved-ones getting landed with a hefty 40 per cent bill on inheritances has intensified since last autumn’s Budget.
The Government announced inheritance tax (IHT) would start being levied on unspent pensions, as it is on assets such as property, savings and investments, from April 2027.
It’s no surprise, then, that wealth planners are telling us about a new rush of enquiries from those wanting to avoid a financial hit to their estates.
They are being deluged by questions about how to place wealth into trust to get it out of reach of the taxman.
That flood of queries is likely to increase, as the threat of a tax raid in this autumn’s Budget intensifies.
Chancellor Rachel Reeves faces another £5 billion black hole in Britain’s finances, after the U-turn on welfare reform upended her plan to cut Government spending.
Experts, including the Institute for Fiscal Studies and Resolution Foundation, have warned that taxes may have to rise again in the autumn.
Matt Conradi, deputy chief executive of wealth manager Netwealth, says trusts can be a useful tool to help reduce inheritance tax and pass on wealth
With hikes to income tax, national insurance and VAT ruled out in Labour’s manifesto pledge, wealth is considered a prime target.
Protecting inheritances is therefore seen as vital by those wanting to pass on their assets.
Setting up a trust is a popular way to beat inheritance tax. They have been used for years by wealthy families to save hundreds of thousands of pounds, and by the super-rich to save millions.
However, many may be surprised to learn a trust is not the catch-all inheritance tax dodge they think. There is confusion over what putting wealth into a trust really means, because it’s a complicated financial area. For one thing, there are many different kinds of trust, not to mention tax charges to consider.
You can exert control over how the money might be used, if you choose the right trust. But you usually cannot continue to benefit yourself from what has gone into it, then still expect your beneficiaries to avoid inheritance tax.
‘Trusts can be a useful tool to help reduce inheritance tax and pass on wealth – but they’re not a simple fix, and they come with costs, rules and paperwork,’ says Matt Conradi, deputy chief executive of wealth manager Netwealth.
‘They are complex, and the wrong set-up can lead to some unexpected tax bills and administration headaches.’
He says that for many families often the simplest and most tax-efficient plan would be to give money away directly.
Heather Rogers, tax expert at This Is Money, says there is plenty of misunderstanding regarding how trusts work and the tax implications
As long as you survive seven years after making a gift, the money usually falls outside your estate for inheritance tax.
You can also make use of tax-free allowances, such as gifting £3,000 a year.
It is worth looking at a combination of ways to reduce death duties. Conradi stresses that a good plan is normally implemented over several years and uses several different methods to blend control and tax efficiency.
When it comes to inheritance tax and trusts, here is what you need to know – but do be aware that if you decide to set up a trust you will need legal and possibly financial advice as well.
Are you even liable to pay inheritance tax?
Around one in 20 estates are large enough to incur inheritance tax, but this is set to rise dramatically when pensions start being counted.
Between the pension changes, a freeze on IHT thresholds until 2030 and the property boom of recent decades, the number of families affected can only rise in years to come.
Those inheriting in house-price hotspots and who have large pensions will bear the brunt.
But you shouldn’t lose sleep – let alone start working on elaborate avoidance tactics – unless you are certain that you are rich enough for inheritance tax to become a problem.
Essentially, you need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up IHT. This basic threshold is called the ‘nil rate band’.
But there is a further chunky allowance – known as the ‘residence nil rate band’ – which increases the threshold to a joint £1 million if you have a partner, own a property and intend to leave money to your direct descendants.
Watch out though, as once an estate reaches £2 million this own- home allowance starts being removed by £1 for every £2 above this threshold. It vanishes completely by £2.3 million.
If you are worth more than your inheritance tax allowance, your beneficiaries will have to hand over 40 per cent of your assets above that to the Government.
What are trusts and how do they vary?
Trusts are a legal arrangement that allow assets to be handed over and managed for the benefit of one or more people.
A ‘settlor’ puts the assets, such as land, property, shares and cash, into the trust, ‘trustees’ look after them and ‘beneficiaries’ ultimately receive them.
With trusts, you are giving money away and the ‘seven-year rule’ still applies.
If you die before the seven years are up, inheritance tax is levied on a sliding scale – starting at the full whack of 40 per cent within the first three years.
These are the main types of trust to choose from:
Bare or absolute trusts: These are very simple and give all assets to the beneficiary. There is a trustee but if the beneficiary is 18 or older they can access the assets at any time.
Trustees can keep control until beneficiaries reach that age – but even 18 might seem too young to many, especially if large sums are involved.
You don’t have to pay an inheritance tax charge on the assets going in, and because the money is treated as belonging to the beneficiary it passes out of your estate entirely.
Discretionary trusts: You can tailor the rules for the trust to suit the people involved and the circumstances, and therefore exercise control through how it is set up and by being a trustee yourself. For example, you can decide how and when the beneficiaries will receive income and assets.
But if as the settlor you benefit from the trust – such as via income or rent – this makes it ineffective for avoiding inheritance tax because you are regarded as having made a ‘gift with reservation’.
Assuming you do not benefit, there are still rules and tax charges. Every seven years you can transfer up to £325,000 individually, or £650,000 from a couple, into a discretionary trust tax-free. On anything over that, you are charged 20 per cent of the value of assets being put in the trust (this is offset if you die and the seven-year rule kicks in, but cannot be reclaimed if you survive seven years).
Every ten years, there is a further 6 per cent tax charge on the excess over the nil rate band.
Discounted gift trust: You can gain benefit from the trust, typically an income, while still making a gift into it that is inheritance tax proof.
Loan trust: This is suitable if you want to set up a trust for inheritance tax purposes but think you might need the money back at some point.
The trustees can invest the money outside of your estate for inheritance tax, but you can opt to get it back. Heather Rogers, the tax expert for our sister website This Is Money and founder of Aston Accountancy, says: ‘The most common misconceptions I come across in my professional life concern trusts.
‘There is plenty of misunderstanding regarding how they work and the tax implications.
‘There seems to be a widely held belief that if you move assets into trust there will be no tax to pay at all. Unfortunately, this is rarely the case.’
Are there any pitfalls to look out for?
Trusts can get really complicated. Different types have separate tax and reporting rules, and you must consult a professional on which is the most suitable for your family circumstances, and to set it up.
The legal and tax reporting requirements for a trust are often misunderstood, says Lisa Caplan, director of Charles Stanley Direct Advice And Guidance.
‘People often ask me if they can put their home into a trust for their children, and don’t realise that if they continue to live in the house their estates will be hit by the rules around “gifts with reservation”.’
Caplan says you can keep control of your assets and avoid inheritance tax with a discretionary trust if you are both a settlor and also a trustee, because you can decide on investments and when to make payments to beneficiaries. She adds: ‘There are legal costs involved in setting up a trust, and the trustees are required to register the trust with HMRC and complete regular tax returns for the trust.’
What about life insurance in trust?
There is a separate use of a trust when it comes to inheritance tax, which involves life insurance. Often this is used to ensure beneficiaries won’t be landed with an unaffordable tax bill before they get access to your estate.
They will get just six months, kicking off from the last day of the month after your death, to calculate what inheritance tax is owed and hand it over. The bill must be paid up front, before probate is granted to gain control of a deceased person’s funds.
There are ways around the problem, including having banks make payments from the deceased’s accounts direct to HMRC, paying the bill in instalments or taking out a loan using the estate assets as collateral.
But if you want to plan ahead, you can take out a whole of life insurance policy (which lasts until death) and put it in trust. It then isn’t in your estate for inheritance purposes. You can appoint one or more beneficiaries of the trust, who will be paid the full life insurance sum due when you die.
Typically, people insure their life for the sum they think their beneficiaries will have to fork out in inheritance tax, to offset their liability.
However, whole of life insurance premiums can be high, especially as you get older, and if you cancel a policy you immediately lose all the benefits of taking it out in the first place.
