IHT & Estate Planning
Last Updated: 6 Apr 24 7 min read
1. Key Points
4. How is a Gift Trust structured?
5. How do you set up a Gift Trust?
6. What access do settlors and the beneficiaries have to the trust fund?
7. What IHT is payable when using a Gift Trust?
A Gift Trust is an IHT planning arrangement that allows the investor to carry out IHT planning whilst retaining a degree of control. There are 2 types available Absolute and Discretionary.
Under an Absolute trust the beneficiaries are named at outset on the deed and cannot be changed at a future date. Under a Discretionary trust there are normally no named beneficiaries but instead a class of prospective beneficiaries. This class normally includes children, grandchildren and so on. Typically the settlor can widen the class to include siblings, nieces, nephews etc. and perhaps non-family beneficiaries if appropriate.
Clients may not be quite ready to pass funds outright to their beneficiaries. They may have “wayward” adult children who have gambling issues, alcohol issues or they have concerns over their sons/daughters choice of partners. They may be concerned that their son or daughter may get divorced and they don’t want their hard earned cash being counted as an asset. There are lots of reasons why individuals do not want to pass on their wealth directly to their beneficiaries. There are two types commonly available which are Absolute gift trusts and Discretionary gift trusts.
Absolute trusts are normally used for minor children due to the fact that on reaching age 18 (16 if written under Scot’s law) the beneficiary is entitled to the trust fund.
Discretionary trusts offer more flexibility for the trustees.
Gift Trusts are typically used in conjunction with insurance bonds – both new bonds and existing bonds. The ownership of the bond passes to the trustees of the trust. Clients can subsequently top up a bond that is held in a gift trust.
In the main if it’s a new bond being placed into a new trust, the settlor (the person who is creating the trust) may be able to date both the bond application and the trust deed the same day. If it’s an existing bond that the settlor is placing into trust the trust deed will be effective from the date that the last person signs the trust deed.
Settlors have absolutely no access to the trust fund whatsoever – you will normally find a settlor exclusion clause within the deed along these lines –
Settlor exclusion clause
The Trust Fund shall be possessed and enjoyed to the entire exclusion of the Settlor and of any benefit to him by contract or otherwise and no provision of this Settlement and no discretion or power shall operate so as to allow any of the capital or income of the Trust Fund to become payable to or applicable for the benefit of the Settlor in any circumstances whatsoever.
In respect of the beneficiaries this depends on whether it is an Absolute trust or a Discretionary trust that has been chosen.
Under an Absolute trust – the beneficiaries can demand the trust fund once they reach age 18 (16 if written under Scot’s law) and the trustees are legally obliged to inform the beneficiary that the trust fund exists. The trust fund will form part of the beneficiary’s estate for IHT. If an absolute beneficiary dies the trustees have to look at the will or follow intestacy rules to see who will then benefit.
Under a Discretionary trust, it’s up to the trustees to decide who will benefit and when they will benefit from the trust fund. As long as the beneficiary is in the class of beneficiaries the trustees can allocate funds to them. This is why clients should choose their trustees wisely as ultimately they will be dealing with the trust fund. It is advisable for clients to lodge a letter of wishes with the trustees to give them some guidance, after their death, as to how they want the trust fund divided up. Remember that a discretionary beneficiary cannot demand monies from the trustees nor does this form part of their estate for IHT while inside the trust.
If the beneficiaries would like the trust to be wound up but the trustees are not in agreement or do not have the necessary powers to end the trust, then the old 1841 English trusts law case of Saunders v Vautier may help. The principle is that if all the beneficiaries are adults with full capacity they can act unanimously to wind up the trust and distribute the trust fund. This principle should apply to a discretionary trust at least where the class of beneficiaries is closed. For this type of planning legal advice should be sought.
A transfer into a Gift Trust will either be a PET or a CLT depending on whether an Absolute trust or a Discretionary trust has been chosen. If a transfer of value is more than the available annual exemption then the excess is the chargeable amount of the PET or the immediately chargeable transfer.
Absolute Gift Trust
Under an Absolute trust the gift creates a PET which after seven years from the date of the gift becomes exempt from IHT. If the settlor dies within the seven years, the PET becomes chargeable and the transfer must be cumulated with the death estate. The transfer must be cumulated with any subsequent lifetime transfers, and the value transferred (after cumulation with earlier transfers ) may become chargeable in its own right and is cumulated with the death estate to calculate IHT payable.
Discretionary Gift Trust
Under a Discretionary trust the gift creates a CLT which may attract an entry charge if the value of the gift when added to any other CLT’s made in the previous 7 years exceeds the settlor’s current nil rate band. Again CLTs drop out after seven years as long as no PETs are created after the CLT. If a settlor creates a mixture of PETs and CLTs this can lead to a 14 year timeline. If a PET fails and becomes chargeable it pulls in any CLTs made within 7 years of the failed PET thus potentially going back 14 years. As gifts are placed in the order they were made, starting with the oldest and moving towards the date of death. CLTs made in the 7 years before the “failed” PET will use nil rate band first, meaning that there could be more IHT due than anticipated on the “failed” PET. Note however that the death estate is taxed as normal.
Discretionary trusts may also be subject to periodic charges every 10 years and exit charges which are explained here.
Remember gifts i.e. PETs and CLTs eat into the nil rate band in chronological order thus when calculating any IHT liability they will be applied first against the nil rate band.
Don’t forget settlors can top up both Absolute or Discretionary trusts it just creates a new transfer i.e. PET or CLT with the 7 year clock starting from the top up date for this new premium
When a chargeable event occurs within the trust, the tax on the gain is assessed as follows.
Absolute Gift Trust
Where a chargeable event arises under an Absolute trust, the gain is assessed on the beneficiaries of the trust in proportion to their share of the trust fund. However if the settlor of the trust is a parent of the beneficiary and the gain arises whilst the beneficiary is unmarried and under age 18, any gain over £100 will be assessed on the settlor of the trust.
Discretionary Gift Trust
Where a chargeable event arises under a discretionary trust, the gain is assessed on the settlor if alive and UK resident. The settlor is also assessable throughout the tax year of their death. If the settlor cannot be taxed (i.e. non UK resident or tax year after death) then UK resident trustees are liable. If the trustees cannot be taxed because they are non UK resident, then a UK beneficiary receiving a benefit under the trust from the gain will be taxable on that amount with no top slicing relief or basic rate credit on a UK bond.
If the trust is set up on a joint settlor basis with the settlors as lives assured there is potential for half of the gain to be assessed at the trustee rates of tax. After first death, when the remaining settlor dies in a later tax year (who is the last life assured) the bond will automatically come to an end and the gain is assessed half on the settlor who has just died and half at trustee rates of tax. It may be worth considering younger lives assured, subject to insurable interest, when setting up a joint discretionary trust.
Trustees are able to assign segments to beneficiaries as long as they are over age 18 for tax planning reasons. The assignment is not a chargeable event but a distribution from the trust fund. Also trustees may be able to irrevocably appoint segments under bare trust to selected beneficiaries under 18 so that subsequent gains are assessed on the child. If however the settlor is a parent then the anti avoidance parental settlement rules could apply.
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