An Alternative Way of Gifting
If you want to gift money out of your estate but don’t want to hand it straight to children, the next best option is to use a trust. Trusts are often over complicated by a financial industry that thrives on complicating things to either justify high charges or lock clients into their products (or both).
For most people, a simple discretionary trust works perfectly well for gifting money to save IHT and retaining control of the money. A gift to a discretionary trust will only fall out of the estate after seven years have passed, like most gifts.
The biggest myth around is that the tax liability falls over the course of the seven years, but that only applies if a gift is larger than the nil rate band (£325,000 per person) and only to the excess over the nil rate band. As gifts more than this amount to a discretionary trust have an initial tax of 20% of the excess applied at outset (a lifetime rate of death tax if you can believe it), it is rare to see more than £325,000 per person gifted to this type of trust and therefore rare to see the reducing rate apply.
As the gift falls out of the donor estate after seven years, it is possible to gift £325,000 per person every seven years. Someone starting this process early enough in retirement can therefore successfully gift away £975,000 over 21 years (more if they start earlier). As we have been advising for 20+ years, we now have several clients on their third set of nil rate band gifts. This is sufficient for most people whose estates are liable to inheritance tax, particularly as you can double these numbers for married couples.
We do look after many clients whose estates have grown to be larger than this level of gifting will tackle. For these clients there are additional opportunities to avoid IHT that we will explore in later sections.
A discretionary trust comes with some ongoing tax compliance and does have a 6% charge on the funds more than the nil rate band (generally growth) every ten years. However, many families (including some of the wealthiest landowners in the UK) think that this is a much better tax to pay than 40% of the whole value.
There are three uses of discretionary trusts that result in immediate exemption from IHT without the need to wait the seven years. All rely on other exemptions but enable an immediate reduction in the next generation’s IHT bill, whilst the donor retains control over the money as a trustee.
Gifts of surplus income into these trusts are immediately exempt. As we looked at in the previous section, this relief requires you to gift regularly to the trust and to have a genuine surplus between net income and total expenditure. It is particularly useful for high earners in the later years of a career and is often the first IHT avoidance steps an individual will take.
Gifts of an inheritance into these trusts are immediately exempt if that is done via a deed of variation to the donor’s will. The key benefit of this type of trust is that the recipient can be trustee and beneficiary as they weren’t the one to gift the money (for IHT purposes it was the deceased). The deed of variation does not involve the other beneficiaries, but it must happen within 2 years of the date of death. We very rarely advise our clients to accept inheritances unless they are small. Why absorb further funds into an estate already liable to inheritance tax, when you can avoid this and still access the funds?
Gifts of an already qualifying business relief investment into these trusts are also immediately exempt. We will look at Business Relief (BR) in more detail in the next section, but it must remain a BR qualifying asset in the trust to keep the exemption.
For now, let’s look at why advisers often recommend other types of trust.
The simplest is a Bare Trust and they do have their uses. A Bare Trust is not limited to £325,000 per person, per seven years like a Discretionary Trust. This allows for much larger gifts but has the one significant disadvantage that the money must go to the person named as the beneficiary and this cannot be changed. They will receive the money at 18, which many clients feel is too early or later on if the payout depends on the life of someone else. The inflexibility of these trusts has led in our experience to children and young people receiving the money far too early in life and it leads in some cases to very poor outcomes.
You will often here about Discounted Gift Trusts (DGT) being recommended. They are sold on the basis that the donor is uncertain about whether they can afford to give the money away. A DGT pays a set monthly amount of capital back to the original donor to lessen the likelihood that they will regret the amount gifted. The significant downside of these trusts as that the capital can only be passed to the beneficiaries when the donor or donors finally die. As this can be very late in life, it means that the beneficiaries themselves may be in mid-late retirement and could have done with the money earlier. We have seen many clients locked into these trust products by past advisers (who are locking in a valuable income stream for themselves) when a more flexible series of gifts and discretionary trusts would have worked better.
Another commonly used trust is a loan trust. This has the benefit of the donor being able to access the initial capital placed into the trust as this is structured as a loan rather than a gift. The growth on this loan is outside of the donor’s estate and they again have the comfort of still being able to access some money if needed. The downside is that a loan trust is very slow in avoiding IHT and at some point, a decision might be needed as to whether to convert the loan into a gift and start the seven year clock ticking.
When considering advice from anyone, look at where the incentives lie. If an adviser charges a percentage on all monies invested, are they more likely to recommend a complex long-term trust or a direct gift to a family member to help repay a mortgage? They get paid on the first but lose money on the second. Their incentives are misaligned with yours as the client. Paying a flat monthly fee means that the adviser is paid regardless of the advice they give and therefore the incentives are completely aligned.
Trust planning is available to Altor clients in our Core Service.
Nothing on this website or its links constitutes a personal recommendation; the information contained is designed to be informative but not to be relied upon as individual circumstances could affect the relevance of this guidance.