Reducing Inheritance Tax With a Trust

Inheritance Tax has the potential to impact on the financial well-being of tens of thousands of households across the country. A much hated tax, it threatens to reduce your dependants’ inheritance by a significant amount. However, Inheritance Tax (IHT) is sometimes referred to as the ‘voluntary tax’; there are ways in which your IHT liability, if you have one, can be mitigated. Amongst the most effective methods by which this can be achieved is the establishment of a trust.

What is a Trust?

A trust is a legal arrangement that allows property to be held by one party for the benefit of a different party. The trust is administered by a trustee or trustees; the rights and responsibilities of this party are established in the trust instrument – that is, the document which establishes the trust. The key principle is that the settlor (that is, the individual establishing the trust) is able to give up the legal title to some of their assets. Depending on the nature of the trust, those assets can then be made available for the benefit of the settlor or of another party.

Trusts and Inheritance Tax

Trusts are amongst the most important tools in the fight against Inheritance Tax. As has been explained, they allow an individual to give up the legal title to their assets, but retain some benefit. In this way, assets placed in trust are not treated as part of the estate of the individual in question. This is important, because Inheritance Tax is levied on a person’s estate; it is currently charged at a rate of 40 per cent on everything over a total value of £312,000.

The trust instrument can be written in such a way as to guarantee that your assets are passed on to the beneficiaries of your choice. Indeed, trusts of this kind are frequently established in an individual’s will; these ‘testamentary trusts’ require relatively little paperwork to set up, although it is generally recommended that you should seek professional advice in order to ensure that the trust is legally sound.

Types of Trust

Previously, Nil-Rate Band Discretionary Trusts were widely used for the avoidance of Inheritance Tax – which is perfectly legal. However, the Chancellor announced in 2008 that married couples and those in civil partnerships would automatically be able to pass onto each other their IHT allowance, known as the ‘nil-rate band’. However, if you are not married and the value of your estate exceeds the nil-rate band of £312,000, you should still consider setting up a trust to mitigate your Inheritance Tax liability.

There is a wide variety of trust types, some of which are unsuitable for the purposes of Inheritance Tax avoidance. Testamentary trusts are most frequently used for Inheritance Tax avoidance or mitigation. However, if you have a particularly high net worth and you are not married or in a civil partnership, you may also find that a Nil-Rate Band Discretionary Trust is suitable. The latter has fallen out of frequent use since the Chancellor’s 2008 announcement, but still serves a number of purposes.

Further information on choosing a trust type and establishing a trust is available in articles elsewhere on this site.