Use Of Trusts In Estate Planning

Inheritance Tax is a death tax that is payable if somebody dies and the net value of their estate is in excess of £325,000.  Married couples each get their own allowance, so they would be jointly entitled to £650,000 (i.e. £325,000 x 2).

If an individual had an estate worth, say, £425,000, then the first £325,000 would be tax free but the remaining £100,000 will be taxed at 40%, resulting in a potential tax bill of £40,000.

Most people don’t like the idea of paying any sort of tax and when it comes to Inheritance Tax, then there are a number of ways in which people can avoid having to pay this particular tax.

One option is to use trusts when people come to sort out their estate planning.  A trust allows someone (the Settlor) to transfer or gift a proportion of their assets without completely losing control of those assets by placing them with a third party (the Trustees) to then administer on behalf of either the Settlor or others (the Beneficiaries).

The benefits of using trusts in estate planning to reduce Inheritance Tax is that it enables people to reduce the value of their estate for Inheritance Tax calculation purposes without making an outright gift, which is something that some people are reluctant to do if the potential beneficiaries are still very young or aren’t used to handling sums of money.

Trusts allow for a proportion of a person’s assets to be passed on to others such as family members in a tax efficient manner under the control of the Trustees who can sometimes include the person who owned the assets in the first place (the Settlor).

There are many different types of trust but there are four main types which are bare trusts, interest in possession trusts, discretionary trusts and charitable trusts.

Bare Trusts – With a bare trust, then the person states who the beneficiaries are right at the beginning and then these are fixed.  With a bare trust, the assets both the income and capital can be claimed by the beneficiaries when they reach 18.

Interest In Possession – An interest in possession trust is where the beneficiaries have a right to the income from the trust after expenses and the Trustees usually have to pass all the income over to the beneficiaries.  So as far as the capital is concerned, then the beneficiaries usually don’t have any rights in relation to that and the capital will often pass to a different beneficiary or beneficiaries in the future.

Discretionary Trust – The third type of trust is a discretionary trust.  With this, then it is the Trustees who decide what happens to both the income and the capital throughout the duration of the trust and how to distribute it.  This means that it is a very flexible trust.  However, the Trustees have to be people who can be trusted to make the right decisions.  There are often a wide range of beneficiaries and no one beneficiary has an absolute right to either income or capital from the trust because the final decision as to who gets what rests with the Trustees.  Discretionary trusts are useful in that it allows the Trustees to make decisions based on what they feel is right and fair and appropriate at the time rather than the Settlor making that decision right at the outset. Discretionary trusts cannot continue forever and they usually last for up to a maximum of 80 years.

Charitable Trusts – The fourth type of trust is a charitable trust.  These have been traditionally divided into four groups; trust for the relief of poverty; trusts for the advancement of religion; trusts for the advancement of education and trusts for other purposes which are of public benefit.  Charitable trusts have a number of advantages especially in relation to tax.  However, these are complicated and specialist advice is often needed.