Wealth preservation

Making the most of different solutions

Decreasing term assurance
Decreasing term assurance can be arranged to cover a potential Inheritance Tax liability and used as a Gift Inter Vivos policy (a gift given during the life of the grantor who no longer has any rights to the property and can not get it back without the permission of the party it was gifted to). This is a type of decreasing term plan that actually reduces at the same rate as the chargeable Inheritance Tax on an estate as a result of a Potentially Exempt Transfer (PET).

For example, if you gift part of your estate away before death, then that part is classed as a PET, meaning that for a period of seven years there could be tax due on the transfer. This amount of tax reduces by a set amount each year for seven years.

The Gift Inter Vivos plan is designed to follow that reduction to ensure sufficient money is available to meet the bill if the person who gifted the estate dies before the end of the seven-year period.

Such policies should be written in an appropriate trust, so that the proceeds fall outside your estate.

Business and agricultural property
Business and agricultural property are exempt from Inheritance Tax.

Business Property relief: To qualify, the property must be relevant business property and must have been owned by the transferor for the period of two years immediately preceding death. Where death occurred after 10 March 1992, relief is given by reducing the value of the asset by 100 per cent. Prior to 10 March 1992, the relief was 50 per cent.

Agricultural Property relief: Agricultural property is defined as agricultural land or pasture and includes woodland and any buildings used in connection with the intensive rearing of livestock or fish if the woodland or building is occupied with agricultural land or pasture and the occupation is ancillary to that of the agricultural land or pasture, and also includes such cottages, farm buildings and farmhouses, together with the land occupied with them as are of a character appropriate to the property. Where death occurred after 10 March 1992, relief is given by reducing the value of the property by 100 per cent (certain conditions apply). Prior to that date the relief was 50 per cent.

Woodlands relief: There is a specific relief for transfers of woodland on death. However, this has become less important since the introduction of 100 per cent relief for businesses that qualify as relevant business property.

Where an estate includes woodlands forming part of a business, business relief may be available if the ordinary conditions for that relief are satisfied.

When a woodland in the United Kingdom is transferred on death, the person who would be liable for the tax can elect to have the value of the timber ñ that is, the trees and underwood (but not the underlying land) ñ excluded from the deceased’s estate.

If the timber is later disposed of, its value at the time will be subject to Inheritance Tax. Relief is available if:

an election is made within two years of the death, though the Board of HM Revenue & Customs have discretion to accept late elections, and
the deceased was the beneficial owner of the woodlands for at least five years immediately before death or became beneficially entitled to it by gift
or inheritance.

The Pre-Owned Assets Tax
Pre-Owned Assets Tax (POAT), which came into effect on 6 April 2005, clamped down on arrangements whereby parents gifted property to children or other family members while continuing to live in the property without paying a full market rent.

POAT is charged at up to 40 per cent on the benefit to an individual continuing to live in a property that they have gifted but are not paying a full rent, and where the arrangement is not caught by the gift with reservation rules.

So anyone who has implemented such a scheme since March 1986 could fall within the POAT net and be liable to an income tax charge of up to 40 per cent of the annual market rental value of the property.

Alternatively, you can elect by 31 January following the end of the tax year in which the benefit first arises that the property remains in your estate.

Rental valuations of the property must be carried out every five years by an independent valuer.

A gift with reservation

Getting the full benefit of a gift to the total exclusion of the donor

A gift with reservation is a gift that is not fully given away. Where gifts with reservation were made on or after 18 March 1986, you can include the assets as part of your estate but there is no seven year limit as there is for outright gifts. A gift may begin as a gift with reservation but some time later the reservation may cease.

In order for a gift to be effective for exemption from Inheritance Tax, the person receiving the gift must get the full benefit of the gift to the total exclusion of the donor. Otherwise, the gift is not a gift for Inheritance Tax purposes.

An outright gift
For example, if you give your house to your child but continue to live there rent free, that would be a gift with reservation. If, after two years, you start to pay a market rent for living in the house, the reservation ceases when you first pay the rent. The gift then becomes an outright gift at that point and the seven- year period runs from the date the reservation ceased. Or a gift may start as an outright gift and then become a gift with reservation.

Alternatively, if you give your house to your child and continue to live there but pay full market rent, there is no reservation. If over time you stop paying rent or the rent does not increase, so it is no longer market rent, a reservation will occur at the time the rent stops or ceases to be market rent.

The value of a gift for Inheritance Tax is the amount of the loss to your estate. If you make a cash gift, the loss is the same value as the gift. But this is not the case with all gifts

Giving away wealth

Tax-efficiently passing on parts of your estate

There are some important exemptions that allow you to legally pass your estate on to others, both before and after your death, without it being subject to Inheritance Tax.

Exempt beneficiaries
You can give things away to certain people and organisations without having to pay any Inheritance Tax. These gifts, which are exempt whether you make them during your lifetime or in your will, include gifts to:

your husband, wife or civil partner, even if you’re legally separated (but not if you’ve divorced or the registered civil partnership has dissolved), as long as you both have a permanent home in the UK

UK charities
some national institutions, including national museums, universities and the National Trust
UK political parties

But, bear in mind that gifts to your unmarried partner or a partner with whom you’ve not formed a registered civil partnership aren’t exempt.

Exempt gifts
Some gifts are exempt from Inheritance Tax because of the type of gift or the reason for making it. These include:

Wedding gifts/civil partnership ceremony gifts
Wedding or registered civil partnership ceremony gifts (to either of the couple) are exempt from Inheritance Tax up to certain amounts:
parents can each give £5,000
grandparents and other relatives can each give £2,500
anyone else can give £1,000

You have to make the gift on or shortly before the date of the wedding or civil partnership ceremony. If it is called off and you still make the gift, this exemption won’t apply.

Small gifts
You can make small gifts, up to the value of
£250, to as many people as you like in any one tax year (6 April to the following 5 April) without them being liable for Inheritance Tax.

But you can’t give a larger sum ñ £500, for example ñ and claim exemption for the first £250. And you can’t use this exemption with any other exemption when giving to the same person. In other words, you can’t combine a ësmall gifts exemption’ with a ëwedding/registered civil partnership ceremony gift exemption’ and give one of your children £5,250 when they get married or form a registered civil partnership.

Annual exemption
You can give away £3,000 in each tax year without paying Inheritance Tax. You can carry forward all or any part of the £3,000 exemption you don’t use to the next year but no further. This means you could give away up to £6,000 in any one year if you hadn’t used any of your exemption from the year before.

You can’t use your annual exemption and your small gifts exemption together to give someone £3,250. But you can use your annual exemption with any other exemption, such as the wedding/registered civil partnership ceremony gift exemption. So, if one of your children marries or forms a civil partnership you can give them £5,000 under the wedding/registered civil partnership gift exemption and £3,000 under the annual exemption, a total of £8,000.

Gifts that are part of your normal expenditure
Any gifts you make out of your after-tax income
(but not your capital) are exempt from Inheritance Tax if they’re part of your regular expenditure.

This includes:

monthly or other regular payments to someone, including gifts for Christmas, birthdays or wedding/civil partnership anniversaries
regular premiums on a life insurance policy (for you or someone else)

It’s a good idea to keep a record of your after-tax income and your normal expenditure, including gifts you make regularly. This will show that the gifts are regular and that you have enough income to cover them and your usual day-to-day expenditure without having to draw on your capital.

Maintenance gifts
You can also make Inheritance Tax-free maintenance payments to:

your husband or wife
your ex-spouse or former registered civil partner
relatives who are dependent on you because of old age or infirmity
your children (including adopted children and step-children) who are under 18 or in full-time education

Potentially exempt transfers
If you, as an individual, make a gift and it isn’t covered by an exemption, it is known as a potentially exempt transfer (PET). A PET is only free of Inheritance Tax if you live for seven years after you make the gift.

Trust in your future

Helping you control and protect family assets

One of the most effective ways you can manage your estate planning is through setting up a trust. The structures into which you can transfer your assets can have lasting consequences for you and your family and it is crucial that you choose the right ones. The right structures can protect assets and give your family lasting benefits.

A trust is a legal arrangement where one or more trustees are made legally responsible for assets. The assets – such as land, money, buildings, shares or even antiques – are placed in trust for the benefit of one or more beneficiaries.

The trustees are responsible for managing the trust and carrying out the wishes of the person who has put the assets into trust (the settlor). The settlorís wishes for the trust are usually written in their will or given in a legal document called the trust deed.

The purpose of a trust
Trusts may be set up for a number of reasons,
for example:

to control and protect family assets
when someone is too young to handle their affairs
when someone canít handle their affairs because they are incapacitated
to pass on money or property while you are still alive
to pass on money or assets when you die under the terms of your will – known as a will trust
under the rules of inheritance that apply when someone dies without leaving a valid will (England and Wales only)

There are several types of UK family trusts and each type of trust may be taxed differently. There are other types of non-family trusts. These are set up for many reasons – for example, to operate as a charity, or to provide a means for employers to create a pension scheme for their staff.

What is trust property?
A trust property is a phrase often used for the assets held in a trust. It can include:

money
investments
land or buildings
other assets, such as paintings, furniture or jewellery – sometimes referred to as chattels

The cash and investments held in a trust are also called the trust capital or fund. This capital or fund may produce income, such as interest on savings or dividends on shares. The land and buildings may produce rental income. Assets may also be sold producing gains for the trust. The way income is taxed depends on the type of income and the type of trust.

What is a settlor?
A settlor is a person who has put assets into the trust. This is known as settling property. Assets are normally put into the trust when itís created, but they can also be added at a later date. The settlor decides how the assets in the trust and any income received from it should be used. This is usually set out in the trust deed.

In some trusts, the settlor can also benefit from the assets theyíve put in. These types of trust are known as settlor-interested trusts and they have their own tax rules.

The role of the trustees
Trustees are the legal owners of the assets held in a trust. Their role is to:

deal with trust assets in line with the trust deed
manage the trust on a day-to-day basis and pay any tax due on the income or chargeable gains of the trust
decide how to invest the trustís assets and/or how the assets in the trust are to be used – although this must always be in line with the trust deed

The trust can continue even though the trustees might change. However, there must be at least one trustee. Often there will be a minimum of two trustees: one trustee may be a professional familiar with trusts – a lawyer, for example – while the other may be a family member or relative.

What is a beneficiary?
A beneficiary is anyone who benefits from the assets held in the trust. There can be one or more beneficiaries, such as a whole family or a defined group of people, and each may benefit from the trust in a different way.

For example, a beneficiary may benefit from:

the income only – for example, they might get income from letting a house or flat held in a trust
the capital only – for example, they might get shares held on trust when they reach a certain age
both the income and capital of the trust – for example, they might be entitled to the trust income and have a discretionary interest in trust capital

If youíre a beneficiary you may have extra tax to pay or be entitled to claim some back depending on your overall income.

Trust law in Scotland
The treatment of trusts for tax purposes is the same throughout the United Kingdom. However, Scottish law on trusts and the terms used in relation to trusts in Scotland are different from the laws of England and Wales, as well as Northern Ireland.

When you might have to pay Inheritance Tax on
your trust

There are four main situations when Inheritance Tax may be due on trusts:

when assets are transferred – or settled – into a trust
when a trust reaches a ten-year anniversary of when it was set up
when assets are transferred out of a trust or the trust comes to an end
when someone dies and a trust is involved when sorting out their estate

The right type of trust
Ensure you donít more tax than is necessary
There are now three main types of trusts.

Bare (Absolute) trusts
With a bare trust you name the beneficiaries at outset and these canít be changed. The assets, both income and capital, are immediately owned and can be taken by the beneficiary at age 18 (16 in Scotland).

Interest in possession trusts
With this type of trust, the beneficiaries have a right to all the income from the trust, but not necessarily the capital. Sometimes, a different beneficiary will get the capital ñ say on the death of the income beneficiary. Theyíre often set up under the terms of a will to allow a spouse to benefit from the income during their lifetime but with the capital being owned by their children. The capital is distributed on the remaining parentís death.

Discretionary trusts
Here the trustees decide what happens to the income and capital throughout the lifetime of the trust and how it is paid out. There is usually a wide range of beneficiaries, but no specific beneficiary has the right to income from the trust.

Some trusts will now have to pay an Inheritance Tax charge when they are set up, at 10 yearly intervals and even when assets are distributed. The right type of trust in conjunction with your overall financial planning could help minimise the amount of Inheritance Tax payable. This is a highly complex area and you should obtain professional advice to ensure the right type of trust is set up for your particular circumstances.

Transferring assets

Using a trust to pass assets to beneficiaries

Trusts may incur an Inheritance Tax charge when assets are transferred into or out of them or when they reach a ten-year anniversary. The person who puts assets into a trust is known as a settlor. A transfer of assets into a trust can include property, land or cash in the form of:

A gift made during a personís lifetime
A transfer or transaction that reduces the value of the settlorís estate (for example, an asset is sold to trustees at less than its market value) – the loss to the personís estate is considered a gift or transfer
A potentially exempt transferí whereby no further Inheritance Tax is due if the person making the transfer survives at least seven years. For transfers after 22 March 2006 this will only apply when the trust is a disabled trust
A gift with reservation where the transferee still benefits from the gift

If you die within seven years of making a transfer into a trust, extra Inheritance Tax will be due at the full amount of 40 per cent (rather than the reduced amount of 20 per cent for lifetime transfers).

In this case your personal representative, who manages your estate when you die, will have to pay a further 20 per cent out of your estate on the value of the original transfer. If no Inheritance Tax was due when you made the transfer, the value of the transfer is added to your estate when working out whether any Inheritance Tax is due.

Settled property
The act of putting an asset into a trust is often known as making a settlement or settling property. For Inheritance Tax purposes, each item of settled property has its own separate identity.

This means, for example, that one item of settled property within a trust may be for the trustees to use at their discretion and therefore treated like a discretionary trust. Another item within the same trust may be set aside for a disabled person and treated like a trust for a disabled person. In this case, there will be different Inheritance Tax rules for each item of settled property.

Even though different items of settled property may receive different tax treatment, it is always the total value of all the settled property in a trust that is used to work out whether a trust exceeds the Inheritance Tax threshold and whether Inheritance Tax is due.

If you make a gift to any type of trust but continue
to benefit from the gift you will pay 20 per cent
on the transfer and the gift will still count as part
of your estate. These are known as gifts with reservation of benefit.

Avoiding double taxation
To avoid double taxation, only the higher of these charges is applied and you wonít ever pay more than 40 per cent Inheritance Tax. However, if the person who retains the benefit gives this up more than seven years before dying, the gift is treated as a potentially exempt transfer and there is no further liability if the transferor survives for a further seven years.

From a trusts perspective, there are four main occasions when Inheritance Tax may apply to trusts:

when assets are transferred – or settled – into a trust
when a trust reaches a ten-year anniversary
when settled property is transferred out of a trust or the trust comes to an end
when someone dies and a trust is involved when sorting out their estate

Relevant property
You have to pay Inheritance Tax on relevant property. Relevant property covers all settled property in most kinds of trust and includes money, shares, houses, land or any other assets. Most property held in trusts counts as relevant property. But property in the following types of trust doesnít count as relevant property:

interest in possession trusts with assets that were put in before 22 March 2006
an immediate post-death interest trust
a transitional serial interest trust
a disabled personís interest trust
a trust for a bereaved minor
an age 18 to 25 trust

Excluded property
Inheritance Tax is not paid on excluded property (although the value of the excluded property may be brought in to calculate the rate of tax on certain exit charges and ten-year anniversary charges). Types of excluded property can include:

property situated outside the UK that is owned by trustees and was settled by someone who was permanently living outside the UK at the time of making the settlement
government securities, known as FOTRA (free of tax to residents abroad)

Inheritance Tax is charged up to a maximum of 6 per cent on assets or property that is transferred out of a trust. The exit charge, which is sometimes called the proportionate charge, applies to all transfers of relevant property.

A transfer out of trust can occur when:

the trust comes to an end
some of the assets within the trust are distributed to beneficiaries
a beneficiary becomes absolutely entitled to enjoy an asset
an asset becomes part of a ëspecial trustí (for example, a charitable trust or trust for a disabled person) and therefore ceases to be relevant property
the trustees enter into a non-commercial transaction that reduces the value of the trust fund

There are some occasions when there is no Inheritance Tax exit charge. These apply even where the trust is a relevant property trust, for instance, it isnít charged:

on payments by trustees of costs or expenses incurred on assets held as relevant property
on some payments of capital to the beneficiary where Income Tax will be due
when the asset is transferred out of the trust within three months of setting up a trust, or within three months following a ten-year anniversary
when the assets are excluded (property foreign assets have this status if the settlor was domiciled abroad)

Passing assets to beneficiaries
You may decide to use a trust to pass assets to beneficiaries, particularly those who arenít immediately able to look after their own affairs. If you do use a trust to give something away, this removes it from your estate provided you donít use it or get any benefit from it. But bear in mind that gifts into trust may be liable to Inheritance Tax.

Trusts offer a means of holding and managing money or property for people who may not be ready or able to manage it for themselves. Used in conjunction with a will, they can also help ensure that your assets are passed on in accordance with your wishes after you die.

Writing a will
When writing a will, there are several kinds of trust that can be used to help minimise an Inheritance Tax liability. From an Inheritance Tax perspective, an ëinterest in possessioní trust is one where a beneficiary has the right to use the property within the trust or receive any income from it. Assets put into an interest in possession trust before 22 March 2006 are not considered to be relevant property, so there is no ten-yearly charge.

During the life of the trust there are no exit charges as long as the asset stays in the trust and remains the ëinterestí of the beneficiary.

If the trust also contains assets put in on or after 22 March 2006, these assets are treated as relevant property and are potentially liable to the ten-yearly charges.