Inheritance Tax (IHT) is a significant concern for many families in the UK, as it can substantially diminish the value of assets passed to beneficiaries. In the fiscal year April to December 2024, IHT receipts reached £6.3 billion, marking a £600 million increase from the same period the previous year.
To mitigate this burden, trusts have long been a strategic tool in estate planning. This blog explores how trusts function, their role in reducing Inheritance Tax, and recent legislative changes that may impact their effectiveness.
Understanding Trusts
A trust is a legal arrangement where assets are managed by a trustee for the benefit of designated beneficiaries. The person who establishes the trust, known as the settlor, transfers assets into the trust, and the trustee administers these assets according to the terms set out in the trust deed.
Trusts and Inheritance Tax
Trusts can be structured to reduce IHT liabilities in several ways:
- Potentially Exempt Transfers (PETs): Gifts made into certain types of trusts may be considered PETs, which are exempt from IHT if the settlor survives for seven years after the transfer.
- Discounted Gift Trusts (DGTs): These allow the settlor to gift a lump sum into a trust while retaining a right to receive income from the trust during their lifetime. The value of the gift for IHT purposes is reduced by the present value of the retained income rights, potentially lowering the Inheritance Tax liability.
- Excluded Property Trusts (EPTs): Assets settled into an EPT by a non-UK domiciled individual are typically excluded from the UK IHT net, provided the settlor remains non-UK domiciled.
Recent Legislative Changes
The UK government has introduced significant changes to Inheritance Tax rules, particularly concerning trusts:
- Shift from Domicile to Residence-Based Taxation: Effective from 6 April 2025, IHT will be assessed based on an individual’s residence status rather than domicile. This means that non-UK domiciled individuals who become UK residents may find their worldwide assets, including those held in trusts, subject to IHT.
- Impact on Excluded Property Trusts: For trusts created from April 2025, non-UK assets will have excluded property status only while the settlor is not a “long-term resident” (defined as an individual who has been resident in the UK for at least 10 out of the last 20 tax years immediately preceding the tax year in which the chargeable event arises). Once the settlor becomes a long-term resident, the trust’s non-UK assets may become subject to IHT.
- Changes to Business Property Relief (BPR) and Agricultural Property Relief (APR): From 6 April 2026, trusts holding qualifying business or agricultural assets will have a £1 million allowance for 100% relief. Assets exceeding this threshold will qualify for 50% relief, potentially leading to IHT charges on the excess value.
Strategic Considerations for Families
Given these developments, families should consider the following strategies:
- Review Existing Trusts: Assess current trusts to understand how the new rules may affect them, especially concerning the residence status of the settlor and the nature of the assets held.
- Consult with Professionals: Engage with estate planning professionals to explore options such as discounted gift trusts or other structures that align with the family’s financial goals and the current tax landscape.
- Plan for Future Tax Liabilities: Develop strategies to manage potential Inheritance Tax liabilities, including considering the timing of asset transfers and the use of exemptions and reliefs.
Conclusion
Trusts remain a valuable tool in estate planning, offering mechanisms to reduce Inheritance Tax liabilities. However, recent legislative changes necessitate a thorough review of existing arrangements and proactive planning to ensure that trusts continue to serve their intended purpose effectively. Families are advised to seek professional advice to navigate the evolving tax landscape and implement strategies that best suit their circumstances. For more information, Contact us at The Will Centre and see how our friendly team can help you today!
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