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How trust laws will affect IHT plans By Faith Glasgow
In this year's Budget, the chancellor announced some major changes in the way trusts are taxed. While the Government's official estimate was that only 23,000 existing trusts would be affected, the Law Society initially The changes were finally enacted in the recent Finance Act. Fortunately, the Government relented on some of the changes. However, the Law Society still estimates that up to two million people could be affected. Could you be caught out? The new provisions revolve around trusts, which are essentially a means of giving away assets (such as cash, investments or shares in a house) in such a way that you retain some control. They may be set up during your lifetime or written into your will. There are several types of trust, and they receive different tax treatment. Two types of trust are affected by this legislation - Accumulation & Maintenance (A&M) and Interest in Possession (IIP) trusts. Until the recent changes, these trusts were given special tax treatment - provided you survived seven years after putting assets into trust, there was no inheritance tax (IHT) to pay. Since the Budget, A&M and IIP trusts have been brought into line with discretionary trusts, which are liable to IHT. Now, if you place assets into an A&M or IIP trust, you will immediately be charged 20% on everything over the nil-rate band (NRB - £285,000 for 2006/07). In addition, every 10 years the trust will be charged a further 6% on the value above the NRB, plus a pro-rata exit charge of up to 6% if the fund pays out in the interim. Assets transferred into a trust set up to take effect on your death will be liable for the same charges, as well as an immediate IHT charge at 40% on the value above the NRB. A&M trusts They allow you to pass on the family wealth to your children, but continue to manage it so as to protect your assets from youthful irresponsibility. These trusts would commonly be used to pay for a grandchild's education, while also moving money out of the grandparents' estate and away from the taxman. An A&M trust might be used to ring-fence assets for particular members of a family at an early stage, says Maggie Gonzalez, tax director at BDO Stoy Hayward. "It might also be used to hold certain kinds of property, such as land, which cannot be owned until you're 18," she explains. A&M trustees have control over the way the interest and capital is distributed. The only general stipulation for these trusts prior to the Budget was that the beneficiaries should be benefiting from the trust by age 25 at the latest. But the new provisions change all this. Parents and grandparents who have already set up A&M trusts now face the choice of either giving the child access to the trust at 18 - regardless of their spending habits - or paying the charges in order to retain control. A two-year period of grace has been granted, so parents have until 6 April 2008 to amend the terms of existing arrangements to the effect that the child has 'absolute entitlement' when he or she reaches 18. New A&M trusts can no longer be established to ring-fence assets for children beyond 18 and still benefit from the tax breaks previously available. A&M trusts written into wills have been replaced with 'trusts for bereaved minors'. These are like A&M trusts, but again must pay out at age 18. Parents with an A&M provision in their wills can sacrifice control beyond the child's 18th birthday to avoid paying the ongoing and exit taxes. If you're not prepared to pay the tax, you need to alter your will. Alternatively, an IIP trust (see below) may be a possibility. Interest in possession trusts (IIP trusts) These are flexible structures, designed so that the income from the assets in trust is paid out to named beneficiaries, while the assets themselves remain ring-fenced until the trust is wound up. IIP trusts may also be written into married couples' wills, to give the surviving partner an income for life when the other dies, while ensuring that the capital goes to the children on the second death (a particularly useful feature if the present wife is not their mother). This arrangement takes advantage of the 'spouse exemption', which allows spouses to leave assets to each other free of IHT. IIP trusts are also useful for parents who want to keep control of the cash flow of vulnerable young adults, or for people with a degenerative disease who are worried they may become incapable of managing their finances. Existing arrangements are fortunately not affected by the 6% periodic charge, unless they are altered after 5 April 2008 (for example, to pay income to another named beneficiary - such as another grandchild - instead), at which point the new regime kicks in. If you set up an IIP trust for any reason other than to provide for a disabled person, you will pay an immediate 20% IHT charge on all assets over the NRB, with more tax liable if you die within seven years. The 10-year charges and exit charge will also apply. The Government has dropped a number of requirements for IIP trusts under wills. The pre-Budget position has largely been restored and an IIP in favour of a spouse will now qualify for the spouse exemption once more, meaning no IHT will be a payable. Avoiding the new tax charges Trusts containing only the value of the nil-rate band aren't touched by IHT or the new laws. But many people's wealth is mainly tied up in property, and that's not so easy to deal with. Some assets, such as shares listed on the Alternative Investment Market (AIM), qualify for 100% business property relief if you own them for two years before giving them away through a trust - and that means there's no IHT to pay. Assets that qualify for agricultural property relief are treated in the same way. Contributions to a trust that come from regular income and do not impact on your standard of living can be given away without liability to IHT. If you earn more than you need, the balance after your living costs and income tax can be paid into a trust without any initial charge, though there will still be 10th-anniversary charges. Everyone also has a personal gift allowance of £3,000 a year; and this can be put into a trust without incurring the initial charge. Considering your options If you're interested in using a trust to control assets rather than reduce IHT, your choices are now more restricted. The only exemption to the initial and ongoing charges imposed on a trust set up during your lifetime is when it is for a disabled person. However, the term 'disabled' is very narrowly defined. Parents wanting to set up a trust in their wills to look after their children if they (the parents) die can use a 'bereaved minor' trust - but all the assets will pass to the children when they reach 18. They could also use an IIP trust, which will mean the child will be entitled to the income, but not automatically to the capital. If this trust arises immediately on the parent's death, it will be free of the 6% 10-yearly charges. It makes sense to ask a specialist adviser to review your will, to ensure it does not fall foul of the new rules. To find an inheritance tax planning professional, contact: The Society of Trust and Estate Planners step.org (020 7838 4890) IFA Promotion unbiased.co.uk (0800 085 3250) The Law Society lawsociety.org.uk (0870 606 6575)
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