Introduction To IHT And Trusts Planning

Since the current Chancellor, Rachel Reeves, entered Number 11 Downing Street, there has been a 420% rise in Google searches about trusts and tax planning. These two facts are surely related and it is reasonable to assume that the latter has been caused by the former. Accordingly, this brief discusses setting up a trust, setting up a trust fund to avoid inheritance tax, the benefits of setting up a trust (and the downsides) and specifically setting up a trust for property.

Trust have been around in the Anglo-Saxon world since medieval times when knights heading off on Crusade would transfer the legal ownership of their landed estates to a trusted friend to hold and administer the land for the benefit of their wives, family and heirs until their return. The courts would only recognise the legal owner and so if the friend did not follow the knight’s wishes and tried to misuse the land the knight and his family had to turn to the court of chancery which was an emanation of the King in Council and request that court to deal fairly and justly and enforce the knight’s wishes against the legal owner with regard to the future use of the land.

This led to the distinction between the legal and beneficial ownership of property that we know today in English law and where a trust over land involves legal ownership by the trustees and beneficial and equitable ownership by the persons entitled to the enjoyment of the fruits of that property. This splitting of the legal title and the right of enjoyment of property has had many modern uses, including estate and inheritance tax or “IHT” planning, safeguarding property for children and vulnerable adults, asset protection and commercial real estate and securitisation structures where property is held securely for groups of investors.

What is a trust in the context of IHT planning?

In IHT planning a settlor transfers (or “settles”) property to specific individuals or a company or companies called trustees for them to hold that property legally for the benefit of persons or persons (which can include the settlor) called the beneficiaries. In IHT planning, the objective of the trust is to take the property out of the settlor’s ownership so that it will not count as part of his estate for IHT when they die, but to ensure some control over who enjoys the property in the future.

Do trusts actually reduce Inheritance Tax?

Putting an asset into a trust can potentially save the 40% IHT charge when you die. However, if you die within 7 years of the transfer IHT can still apply but at tapered rates and if you retain any benefit such as continuing to live in a house you put into trust then full IHT continues to apply under the reservation of benefit rules. Putting property into a trust can also give rise to an immediate 20% IHT charge on the value exceeding £325,000 and periodic 6% IHT charges every 10 years while the property remains in the trust plus exit charges when the property leaves the trust.

It is also important to realise that putting your house into trust can result in you losing control of it and along with it any right to occupy it. You should only do this with your main residence if you have an alternative place to live and /or completely trust your trustees. Remember, people’s circumstances can change, as can their relationships and putting your only or main residence into a trust could be something you come to regret over time, along with the legal complexity, costs and reduced mortgageability of the property.

Weigh up the potential tax and legal costs and risks carefully against the perceived advantages, whatever the latter may be, particularly if you are elderly or vulnerable.

Trusts can play a role where the ability to attract local authority funding of care home fees will become an issue in the years ahead, in order to take a property out of your estate for means testing, but that is a complex planning area due to wide-ranging anti-avoidance rules and is a separate topic in itself.

Why were trusts more popular for IHT in the past?

Prior to March 2006 there were no IHT charges on a transfer of property into a life interest trust i.e., where someone had the right to the income, unless the transferor died within 7 years of the transfer but since then such transfers are immediately subject to 20% IHT plus the 10 year periodic charges of 6% plus exit charges.

What are the main tax disadvantages of putting assets into a trust?

In summary, legal and administrative costs, IHT, SDLT and income tax, complexity and lack of flexibility and unforeseen changes in personal, family and financial circumstances. The reservation of benefit rules can also mean that continuing to enjoy the asset will mean that it remains in your estate for IHT purposes on your death and IHT at 40% can apply.

When might a trust be inappropriate?

Putting a property, especially your main residence, into a trust can be inappropriate if it will leave you and your partner at risk of being homeless.

Why are some firms heavily promoting trusts as an IHT solution?

While trusts can provide a benefit in certain very specific circumstances, in general, because of the heavy tax charges and other disadvantages associated with trusts, it is difficult to understand why some firms are promoting trusts so heavily. One is tempted to think that with all the noise surrounding Rachel Reeves and how she may pluck prosperous members of society in order to fund less prosperous members of society, the opportunity to earn professional fees from those who are worried and vulnerable to Reeves’ manouevres may be playing a role in such promotions.

How do I know whether a trust is right for my circumstances?

The best way to do this is to think through the basic principles and weigh the perceived advantages against the definite potential disadvantages as listed above. If in any doubt, take professional inheritance tax advice from a professional adviser who is objective and who will not be interested in upselling you services such as insurance products or investment advice and who is thus financially disinterested in whether you decide to set up a trust or not.

In short, an independent tax barrister would be a good choice because we do not sell financial products, hold client monies nor are we allowed to accept introducer’s commissions for pushing you into the arms of suppliers of financial products.

Conclusion

In a word, be careful if you are thinking that trusts are a simple solution to ward off the Chancellor as she becomes ever more desperate in her search to pluck prosperous members of society in order to pay for our country’s increasingly unsustainable debt and spending burden. Trusts can play a useful role but only in some very specific circumstances.