Since the changes in tax legislation in relation to trusts on 22 March 2006, Trusts have fallen out of favour. However, Trusts are still a good way to protect assets and for Inheritance Tax (IHT) planning. There are several different types of trusts this article focuses on Discounted Gift Trusts and Loan Trusts.
A Discounted Gift Trust (DGT) allows an individual to make a gift of assets to a trust while retaining the right to receive a regular income from the trust for a set period (usually the individual’s lifetime). After the set period or upon the individual’s death, the remaining assets in the trust pass on to the beneficiaries. The value of the gift is “discounted” for inheritance tax purposes, potentially reducing the IHT liability on the gift.
The discount applied to the gift is based on actuarial calculations, which take into account the individual’s age, health, life expectancy, and the retained income period. Therefore the younger and fitter an individual is when setting up a DGT the higher the discount.
For example, Mrs. Smith is a fit and healthy 65 year old wishing to undertake some IHT Planning. If Mrs. Smith settled £500,000 into a DGT trust and the insurance company applied a discount of 55% (£275,000) with Mrs. Smith retaining an annual income of 5% of the funds invested (£25,000 per annum). The £275,000 would outside Mrs. Smith’s estate for IHT immediately, the remaining £225,000 would be a Potential Exempt Transfer (PET), providing Mrs. Smith survived 7 years from the date of the gift no IHT liability would arise. Mrs. Smith would also continue to receive the income well beyond the seven years.
Another trust planning tool for IHT purposes is a Loan Trust.
A Loan Trust is another estate planning strategy for individuals that cannot afford to give up the capital as they still need access to the income. The settlor lends money to the trust, but still retains a right to a regular income each year and the trust then invests the loaned funds.
The loaned funds are not subject to inheritance tax, as they are not considered a gift. Instead, the loan amount is a debt owed by the trust to the settlor. Upon the settlor’s death, the outstanding loan amount is deducted from the value of the individual’s estate for inheritance tax purposes.
For example, Mr. Smith is in his 70s and wishes to set up a trust for the benefit of his grandchildren but needs an income of £10,000 per annum. Mr. Smith settles £375,000 into a Loan Trust, as this a loan there is no IHT due on the gift and it is not a PET. Mr. Smith passes away 10 years after the trust is established and over the 10 years has received annual payments from the trust totaling £100,000. The trust still owes Mr. Smith’s estate £275,000 which is used to reduce the value of Mr. Smith’s estate on death. If the value of the trust has increased in value at the date of Mr. Smith’s death is outside Mr. Smith’s estate for IHT purposes.
It’s important to note that both Discounted Gift Trusts and Loan Trusts are complex estate planning strategies that have specific requirements and potential tax implications and not suitable for everyone. Additionally, tax laws and regulations can change over time, so it’s crucial to seek advice from qualified financial advisors or tax professionals to ensure these strategies align with your specific financial situation and goals.
If you have any further questions you can contact Leanne at PGR accountants Belfast on 02890788870.