Inheritance Tax (IHT) is a tax that is levied on the estate of a deceased person before it is passed on to their beneficiaries Discretionary trusts are a popular estate planning tool used to manage and distribute assets among beneficiaries However, understanding the implications of IHT on discretionary trusts is crucial for effective estate planning.
A discretionary trust is a legal arrangement where the settlor (the person creating the trust) transfers assets to a trustee, who then has discretion over how to distribute those assets among a group of beneficiaries Unlike other types of trusts where the beneficiaries are specified, in a discretionary trust, the trustee has the flexibility to determine who will benefit from the trust and how much they will receive.
One of the key benefits of a discretionary trust is its flexibility The trustee can adapt to changing circumstances and tailor distributions to the needs of the beneficiaries However, this flexibility can also have implications for IHT Since the beneficiaries are not predetermined, the assets held in a discretionary trust are not technically owned by any individual, which can complicate the calculation of IHT liabilities.
When it comes to IHT, the assets in a discretionary trust are treated differently than assets owned outright by an individual In general, the assets in a discretionary trust are subject to IHT every ten years, as well as when assets are distributed from the trust This is known as the 10-yearly charge and exit charge, respectively.
The 10-yearly charge is a tax that is levied on the value of the assets in a discretionary trust every ten years The rate of this tax is currently set at 6% on the value of assets above the nil-rate band, which is £325,000 for the 2021/2022 tax year iht on discretionary trusts. It is important to note that the nil-rate band is cumulative for all discretionary trusts that a settlor has created, so if the total value of assets in all trusts exceeds the nil-rate band, the tax liability can be significant.
The exit charge, on the other hand, is a tax that is levied when assets are distributed from a discretionary trust The rate of this tax is currently set at a maximum of 6% on the value of assets that exceed the nil-rate band at the date of distribution This charge is in addition to any IHT that may be due on the assets themselves.
In addition to the 10-yearly charge and exit charge, there are other factors that can affect the IHT liabilities of a discretionary trust For example, the age of the beneficiaries, the value of the assets in the trust, and the duration of the trust can all impact the amount of tax that is due.
It is also worth noting that there are certain reliefs and exemptions available that can help to reduce the IHT liabilities of a discretionary trust For example, business relief and agricultural relief may be available if the assets in the trust qualify as business or agricultural property Additionally, the transferable nil-rate band allows unused IHT allowances from the estates of deceased spouses or civil partners to be transferred to the surviving spouse or civil partner.
In conclusion, understanding the impact of IHT on discretionary trusts is essential for effective estate planning While discretionary trusts offer flexibility and control over the distribution of assets, they also come with tax implications that need to be managed carefully By working with a professional advisor, settlors can ensure that their assets are protected and their beneficiaries are provided for in the most tax-efficient way possible.