Discretionary trusts have become a popular estate planning tool for individuals looking to protect their assets and provide for their loved ones One key aspect to consider when setting up a discretionary trust is the impact it can have on inheritance tax (IHT) In this article, we will explore the relationship between discretionary trusts and IHT, and how you can navigate this complex area of estate planning.
A discretionary trust is a type of trust where the trustees have the discretion to decide how and when to distribute the assets to the beneficiaries Unlike other types of trusts, such as a fixed trust where the beneficiaries are predetermined, a discretionary trust offers a greater level of flexibility and control This can be particularly useful for individuals who want to provide for family members who may have different needs and circumstances.
However, the flexibility of a discretionary trust can also have implications for inheritance tax planning In the UK, IHT is a tax imposed on the value of an individual’s estate upon their death The current IHT threshold is £325,000, with anything above this amount subject to a 40% tax rate By transferring assets into a discretionary trust, you are essentially moving them out of your estate and potentially reducing the amount of IHT payable on your death.
One important aspect to consider when setting up a discretionary trust is the concept of the “relevant property regime” Under this regime, any assets that are transferred into a discretionary trust are considered as “relevant property” and are subject to various tax charges These tax charges include the entry charge, which is calculated based on the value of the assets transferred into the trust, and the 10-yearly charge, which is levied every 10 years on the value of the trust fund.
The implications of these tax charges can be significant, especially for larger trusts with substantial assets It is important to seek professional advice when setting up a discretionary trust to ensure that the tax implications are fully understood and managed effectively discretionary trusts and iht. One common strategy to mitigate the impact of IHT on a discretionary trust is to make use of the available exemptions and reliefs.
For example, the IHT nil-rate band allows an individual to pass on up to £325,000 of their estate tax-free By making full use of this allowance, you can reduce the amount of IHT payable on your death Similarly, there are other reliefs available for assets that are transferred into a discretionary trust, such as the “normal expenditure out of income” relief This relief allows individuals to make regular gifts out of their income that are exempt from IHT, as long as they do not impact their standard of living.
Another important consideration when it comes to discretionary trusts and IHT is the role of the trustees The trustees have a duty to manage the trust in the best interests of the beneficiaries, which includes considering the tax implications of their decisions Trustees must be aware of their obligations under the relevant tax legislation and seek professional advice when needed to ensure compliance.
Furthermore, the trustees have the discretion to appoint income and capital to the beneficiaries as they see fit This can be a useful tool for managing the tax liabilities of the trust, as income payments are typically subject to a lower tax rate than capital payments By carefully planning the distribution of income and capital, trustees can minimize the overall tax burden on the trust.
In conclusion, discretionary trusts can be a valuable estate planning tool for individuals looking to protect their assets and provide for their loved ones However, it is essential to consider the implications of IHT when setting up a discretionary trust and to seek professional advice to ensure that the tax implications are managed effectively By understanding the relevant tax legislation and implementing appropriate strategies, you can make the most of the benefits of a discretionary trust while minimizing the impact of IHT.