Inheritance tax (IHT) is a tax that is levied on the estate of a deceased person before it is passed on to their beneficiaries Discretionary trusts are a commonly used estate planning tool that allows individuals to have greater control over how their assets are distributed after their death However, it is important to understand how IHT applies to discretionary trusts in order to ensure that the assets are passed on in a tax-efficient manner.
Discretionary trusts are a type of trust where the trustees have the discretion to decide how the income and assets are distributed among the beneficiaries This flexibility can be valuable for individuals who want to provide for their loved ones while still maintaining some degree of control over the assets However, the discretionary nature of these trusts can have implications for the calculation of IHT.
When assets are placed into a discretionary trust, they are considered to be gifts for IHT purposes This means that the value of the assets is subject to IHT at the time they are placed into the trust, as well as potentially when they are distributed to the beneficiaries The rate of IHT that applies to assets placed into a discretionary trust is currently 20%, which is the same rate that applies to lifetime gifts that exceed the annual exemption limit.
One key consideration when placing assets into a discretionary trust is the nil-rate band, which is the amount of an individual’s estate that is exempt from IHT For the 2021/22 tax year, the nil-rate band is £325,000 per person This means that assets placed into a discretionary trust that exceed this amount will be subject to IHT at the rate of 20%.
It is also worth noting that there is an additional threshold called the residence nil-rate band, which may apply if the main residence of the deceased is passed on to direct descendants This additional threshold is currently £175,000 per person for the 2021/22 tax year and may help to reduce the overall IHT liability on assets held in a discretionary trust.
One potential benefit of discretionary trusts when it comes to IHT planning is that they can be used to shelter assets from IHT that would otherwise be payable on the death of the individual iht on discretionary trusts. By placing assets into a discretionary trust, the individual effectively removes them from their estate for IHT purposes, reducing the overall tax liability.
However, it is important to be aware of the potential pitfalls of using discretionary trusts for IHT planning For example, the trustees of a discretionary trust have the discretion to decide how the assets are distributed among the beneficiaries This means that the beneficiaries do not have a legal right to the assets, which can complicate matters when it comes to calculating the overall IHT liability.
In addition, the trustees of a discretionary trust have a duty to act in the best interests of the beneficiaries This means that they must carefully consider the tax implications of any decisions they make regarding the distribution of assets from the trust Failing to do so could result in significant IHT liabilities for the trust and its beneficiaries.
Another potential issue that may arise when using discretionary trusts for IHT planning is the concept of related property Related property is property that is closely associated with the settlor of the trust or their family members If related property is placed into a discretionary trust, it may be subject to IHT at higher rates than other assets in the trust.
Overall, the impact of IHT on discretionary trusts can be complex and may vary depending on the individual circumstances It is important to seek professional advice when considering using a discretionary trust for IHT planning in order to ensure that the assets are passed on in a tax-efficient manner.
In conclusion, understanding the impact of IHT on discretionary trusts is essential for anyone looking to use this estate planning tool to pass on their assets to their loved ones By being aware of the potential tax implications and seeking professional advice, individuals can ensure that their assets are distributed in a tax-efficient manner and that the beneficiaries are not left with a significant IHT liability.