Everyone knows that both are inevitable. When one leads to the other, however, this is a common cause of frustration and irritation. For many people, the estate they’ve accumulated by the end of their lives has been built from after tax income and capital. To suffer inheritance tax (IHT) on it therefore feels like a double-whammy.
The use of lifetime trusts can not only help to save very material sums of IHT but can also help save Income Tax (IT) and Capital Gains Tax (CGT) as well as creating cash flow advantages for the settlor and making income and capital available in a controlled and managed way to beneficiaries just when they need it most.
In terms of IHT, every individual can put up to £325,000 into a lifetime discretionary trust with no immediate IHT if their Nil Rate Band (NRB) is fully available. If they survive 7 years this transfer falls completely out of their estate saving IHT of £130,000 at the current rate of 40%. Subject to affordability, a couple could therefore potentially save £260,000 of IHT if they both set up such a trust.
Whilst few couples may have £650,000 available in cash, many will have large investment portfolios that have accumulated over time and which, subject to a detailed financial plan, might be above and beyond their own requirements for capital and income. To liquidate £650,000 from such a portfolio could trigger significant CGT. However, a properly worded trust which only allows potential beneficiaries (often children and grandchildren) to benefit once they reach the age of 18 can allow a “holdover election” to be used to transfer the investments and the gains into trust with no immediate charge to CGT.
Not only can the trust then use its own CGT allowance of half that of an individual to start to wash out gains but, via a second holdover election, investments and gains can be transferred from the trust to an over-18 beneficiary allowing them to sell the investments and trigger the gains within their own annual exemption.
If that beneficiary has university fees and living costs to pay or a house deposit to find, these transfers from trust to beneficiary could take place a little and often over several years utilising successive CGT annual exemptions of the individual beneficiary. Furthermore, if the taxable income within the trust is also distributed out, it could wash through the personal allowance of the beneficiary allowing all IT to be recovered, or at least to suffer basic rate tax rather than 45% within the trust.
In this way, income and capital gains taxable assets are transferred from the settlor into trust and potentially out of their estate with no immediate tax. It allows the expensive university and early adult years to be funded out of trust assets rather than out of after tax income of the settlor; and it allows income and gains to wash through the allowances of the trust and of the individual beneficiaries resulting in either zero or only a small amount of basic rate IT and CGT.
Whilst this is a complex area of planning requiring legal as well as financial planning advice, the potential tax savings are very significant.
If you think such a strategy might be worth considering in your circumstances, get in touch and we’ll discuss whether it is appropriate to your own situation and financial planning goals and objectives.
RMT Ref 135/01.16/SL