Understanding Discretionary Trusts and Inheritance Tax Planning



MA & CO Accountants Podcast

Inheritance tax (IHT) planning is a crucial aspect of managing your estate and ensuring that your assets are passed on to your beneficiaries efficiently. One effective tool in this planning is the use of discretionary trusts. In this blog post, we'll explore how discretionary trusts work, their tax implications, and how they can benefit you and your loved ones.

What is a Discretionary Trust?

A discretionary trust is a legal arrangement where trustees hold and manage assets on behalf of beneficiaries. The key feature of this trust is that the trustees have the discretion to decide how and when to distribute income and capital among the beneficiaries. This flexibility allows for tailored financial support based on changing circumstances.

Benefits of Discretionary Trusts in IHT Planning

  1. Tax Efficiency: By transferring assets into a discretionary trust, you can potentially reduce your estate's value for IHT purposes.
  2. Control and Flexibility: Trustees can manage distributions to beneficiaries based on their needs and circumstances.
  3. Asset Protection: Trust assets are safeguarded from external claims, such as creditors or divorcing spouses of beneficiaries.
  4. Estate Preservation: Ensures wealth is preserved for future generations according to your wishes.

Utilizing the Nil-Rate Band (£325,000)

The nil-rate band (NRB) is the amount up to which an estate has no IHT to pay. As of now, the NRB is £325,000. Here's how you can leverage this in your estate planning:

Example 1: Transferring Within the Nil-Rate Band

Scenario: You transfer £325,000 into a discretionary trust during your lifetime.

  • Immediate IHT Charge: None, since the amount is within the NRB.
  • Seven-Year Rule: If you survive seven years after the transfer, the amount is fully exempt from IHT.
  • Periodic Charges: No charges, as the trust's value doesn't exceed the NRB.

Benefit: Removes £325,000 from your estate, potentially saving £130,000 in IHT (40% of £325,000).

Exceeding the Nil-Rate Band

Transferring amounts over the NRB can still be beneficial, but it's important to understand the associated charges.

Example 2: Transferring Above the Nil-Rate Band

Scenario: You transfer £500,000 into a discretionary trust.

  • Excess Over NRB: £500,000 - £325,000 = £175,000.
  • Entry Charge: 20% of £175,000 = £35,000.
  • Periodic Charges: At each ten-year anniversary, 6% of the excess value over the NRB is charged.

Benefit: While there's an immediate charge, you potentially save more in the long term. If the £500,000 remained in your estate, the IHT could be £200,000 (40% of £500,000).

Sequential Gifting and the Seven-Year Rule

You can maximize IHT savings by making additional gifts after seven years.

Example 3: Making Additional Gifts

  • Year 0: Transfer £325,000 into a trust.
  • Year 7: Transfer another £325,000 into a new trust.

Benefit: After 14 years, £650,000 is outside your estate, potentially saving £260,000 in IHT.

Trusts Within Wills

Setting up trusts within your will can provide further IHT efficiencies without affecting your assets during your lifetime.

Example 4: Will Trusts

  • Nil-Rate Band Trust: Activated upon death, utilizing your NRB immediately.
  • Residence Nil-Rate Band (RNRB): If applicable, allows up to an additional £175,000 to be passed on tax-free.
  • Interest in Possession Trust: Provides income to a beneficiary (e.g., a surviving spouse) while keeping assets out of the estate for IHT on the second death.

Benefit: Efficiently uses tax allowances, protects assets, and provides for loved ones according to your wishes.

Cost of Setting Up Trusts

Contrary to popular belief, setting up trusts doesn't have to be expensive.

  • Basic Will: £225 – £499.
  • Nil-Rate Band Trust: £525 – £799.
  • Interest in Possession Trust: £395 – £699.
  • Total Estimated Cost: Approximately £1,145 – £1,997.

Note: Trusts within will incur no ongoing costs during your lifetime and are only activated upon death.

Understanding the Cost Range

  • Minimum Total Cost: £225 (Basic Will) + £525 (Nil-Rate Band Trust) + £395 (Interest in Possession Trust) = £1,145.
  • Maximum Total Cost: £499 (Basic Will) + £799 (Nil-Rate Band Trust) + £699 (Interest in Possession Trust) = £1,997.

Competitive Pricing: These ranges reflect competitive market rates, ensuring you receive quality estate planning services at a fair price.

Who Can Benefit from Discretionary Trusts?

  • Individuals with Estates Exceeding the NRB: To reduce IHT liabilities.
  • Parents and Grandparents: Wishing to provide for future generations.
  • Business Owners: Seeking to protect business assets.
  • Those Concerned About Care Costs: Potentially protect assets from being used for long-term care.

Key Takeaways

  1. Start Planning Early: The sooner you begin, the more options are available, especially with the seven-year rule.
  2. Stay Within the NRB When Possible: To avoid immediate charges and maximize tax efficiency.
  3. Consider Professional Advice: Estate planning can be complex; professional guidance ensures compliance and optimal outcomes.

Frequently Asked Questions (FAQ)

1. What is the Nil-Rate Band (NRB) and how does it affect me?

Answer: The Nil-Rate Band is the threshold below which no inheritance tax is payable, currently set at £325,000. Effective use of the NRB through trusts can significantly reduce your estate's taxable value, ensuring more assets pass to your beneficiaries.

2. How does the seven-year rule work in inheritance tax planning?

Answer: If you make a gift and live for seven years after making it, the gift becomes exempt from IHT. This is known as a Potentially Exempt Transfer (PET). Utilizing this rule allows you to progressively remove assets from your estate over time.

3. What are the immediate tax implications of setting up a discretionary trust?

Answer: Transfers into a discretionary trust up to the NRB (£325,000) during your lifetime are free from immediate IHT charges. Amounts exceeding the NRB are subject to a 20% entry charge on the excess.

4. What are periodic and exit charges related to trusts?

Answer: Periodic charges are taxes applied every ten years on the trust's value exceeding the NRB, up to 6%. Exit charges may apply when assets are distributed from the trust, calculated based on the time since the last periodic charge and the amount exiting.

5. Can I be a beneficiary of my own discretionary trust?

Answer: Yes, but if you retain a benefit from the trust assets, they may not be fully removed from your estate for IHT purposes. A settlor-excluded trust, where you do not benefit, is more effective for IHT planning.

6. What is the difference between a discretionary trust and an interest in possession trust?

Answer: In a discretionary trust, trustees decide which beneficiaries receive assets and when. In an interest interest-in-possession trust, a beneficiary has an immediate right to income from the trust assets but not necessarily the capital.

7. Are there ongoing costs associated with trusts?

Answer: Trusts set up within wills generally do not incur ongoing costs during your lifetime, as they become active upon death. Lifetime trusts may have administrative costs for management and compliance, which should be discussed with your advisor.

8. How does the Residence Nil-Rate Band (RNRB) work?

Answer: The RNRB is an additional allowance of up to £175,000 when passing your primary residence to direct descendants. Combined with the NRB, this can allow a married couple to pass on up to £1 million tax-free.

9. Can I transfer more than £325,000 into a trust without paying immediate IHT?

Answer: Not into a discretionary trust without incurring charges. Transfers over the NRB are subject to a 20% entry charge. However, other trusts or planning strategies might allow larger transfers without immediate charges, but these can be complex and require professional advice.

10. Why should I seek professional advice for inheritance tax planning?

Answer: IHT planning involves complex tax laws and regulations. Professional advisors can help you navigate these complexities, ensure compliance, and tailor strategies to your specific circumstances, maximizing the benefits for you and your beneficiaries.

How MA & Co Accountants Can Help

At MA & Co Accountants, we specialize in helping clients navigate the complexities of inheritance tax planning and trusts. Our experienced team can provide personalized advice tailored to your unique circumstances.

  • Comprehensive Estate Planning: We assess your estate and recommend strategies to minimize tax liabilities.
  • Trust Setup and Management: Assistance with establishing and administering trusts that align with your goals.
  • Ongoing Support: We stay updated on tax laws to ensure your estate plan remains effective over time.

Contact us today to schedule a consultation and secure your family's financial future.

Location: London, UK

Comments

Post a Comment

Popular posts from this blog

Understanding Current Corporation Tax Rates and Marginal Relief in the UK

Image
Listen to the MA & CO Podcast Introduction Corporation tax is a key part of running a business in the UK. It is important to know the current corporation tax rates and understand how marginal relief works. This can help you plan for your business expenses and ensure you are not paying more tax than needed. In this guide, we will explain the corporation tax rates and how marginal relief applies to businesses with different levels of profit. 1. Current Corporation Tax Rates (as of 2024) In the UK, corporation tax rates depend on how much profit your company makes. Here are the main rates for 2024: Small Profits Rate : If your company makes up to £50,000 in profits, you will pay 19% in corporation tax. Main Rate : If your company makes more than £250,000 in profits, you will pay 25% . Marginal Rate : If your profits are between £50,001 and £250,000 , you can get marginal relief , which means you pay a rate between 19% and 25% . Taxable Profits (£) Corporation Tax Rate Margin...
Read more

Maximizing Profitability: Smart Tax Planning Strategies for UK SMEs in 2025 💰

Image
Did you know that UK small businesses collectively overpay an estimated £5.7 billion in taxes annually due to inadequate tax planning? As a small or medium-sized business owner, you're likely juggling countless responsibilities while trying to grow your company. Amid this balancing act, strategic tax planning and financial optimisation often take a back seat—yet these are precisely the areas that can significantly impact your bottom line. In today's challenging economic climate, every pound saved through efficient tax planning is a pound that can be reinvested in your business's growth. At MA & Co Accountants, we specialise in helping UK SMEs navigate the complex tax landscape to maximise profitability while ensuring full compliance with all regulations. Understanding the UK Tax Landscape for SMEs in 2025 🔍 The UK tax system is constantly evolving, with new regulations and requirements that can be overwhelming for busy business owners. Recent changes in tax legislation...
Read more

📈 Everything You Need to Know About the Self-Assessment Tax Return Deadline

Image
Listen to the MA & CO Podcast The   self-assessment tax return deadline   is a critical date for millions of taxpayers in the UK. Missing this deadline could lead to fines, penalties, and unnecessary stress. With around 5.4 million people still needing to file their returns before the January 31 deadline, it’s important to understand the process, avoid mistakes, and stay informed about potential scams. This guide will explain everything you need to know in simple, clear language. 📅   Key Dates and Penalties 🔔   Important Deadlines January 31:   Deadline for submitting your self-assessment tax return online and paying any tax owed. April 30:   Late filing penalties increase if the return is still outstanding. 📉   Penalty Breakdown Timeframe Penalty 1 day late            £100 fixed fine (applies regardless of tax owed). After 3 months            £10/day for up to 90 days (£900 maximum). A...
Read more