Are trusts still the most tax-efficient option for family wealth transfers?

Wednesday, November 23, 2011 | Posted by: Mike Hyland
Categories: Personal, Protecting your wealth | Tags: tax, tax planning, property, capital gains tax, inheritance tax, CGT, income tax, IHT, trusts, Mike Hyland, inheritance, minimise, Family Limited Partnerships, family wealth, succession, family investment company, relevant property, 10-year charge, wealth planning

After the changes to the taxation of trusts in recent years, we consider whether they are still a viable option for family wealth and succession planning, and introduce a couple of alternatives to trusts.

Changes to how trusts are taxed
Trusts have traditionally been a mainstay of family wealth and inheritance tax (IHT) planning, offering wealthy individuals and families the chance to pass assets down generations in a tax-efficient manner.

However, there have been sweeping changes in recent years to the taxation of trusts, making them a much less-favoured vehicle. In broad terms:

• The making of gifts by individuals to virtually all new trusts will trigger a 20% upfront IHT charge, after the donor’s nil rate band or IHT threshold has been exceeded.
• Most trusts fall into the ‘relevant property’ regime, which means that IHT charges at up to six percent on roughly the value of the trust less reliefs are suffered every 10 years and when assets leave the trust.
• The highest rates of income tax and capital gains tax currently apply to most trusts, being 50% and 28% respectively.

Given all of the above, you might think that UK trusts had no future in tax-efficient wealth planning. But trusts remain popular because they allow clients to pass wealth down generations without providing access to it at too young an age, and they allow for changes in beneficiaries’ entitlements under the trust without triggering tax charges.

When to use trusts
The key issue in using UK trusts tax-efficiently is to fund the trust without crystallising the immediate 20% IHT charge – so the following could be considered:

• An individual can gift up to £325,000 (the current nil rate band) into a trust every seven years.
• Excess income – broadly that not required to sustain the lifestyle of the donor – can be gifted into trust. This is more complicated than it sounds to get the relief so advice should be sought before proceeding.
• Assets qualifying for business property relief or agricultural property relief can be transferred to trust, enabling significant value to pass into trust (although be mindful of jeopardising the Entrepreneurs’ Relief position on business assets). This may not reduce the immediate IHT charge to nil unless the asset qualifies for 100% relief on the whole value.
• Reversionary interest trusts can be used to pass significant sums into trust without an IHT charge, although there is risk to this planning as it seeks to circumvent the legislation.

With these options, UK trusts are likely to remain a key tool in wealth planning. However, there are individuals and families for whom the above options are not available or sufficient to deal with the assets they wish to shelter from IHT.

What are the alternatives to trusts?
In these instances, an alternative to a trust, such as family limited partnership (FLP) or a family investment company (FIC), can be considered. The benefits of FLPs have been discussed in a previous post, and in my next post I will be looking at the potential benefits of a FIC.

You might also find these posts useful:

* Avoiding inheritance tax with business property relief? Beware these nightmare scenarios…
* Cold comfort on farms’ agricultural property relief
* Read our recent blog series all about updating your pension planning