Inheritance Tax (IHT) has barely been out of the headlines since the chancellor, Rachel Reeves, announced key changes to the levy in her 2024 Autumn Budget.
While the standard rate of IHT remains at 40% in most cases, Reeves introduced the following significant reforms:
- The thresholds for passing on wealth without incurring IHT (the nil-rate bands) have been frozen until 2030.
- Inherited pensions are set to be subject to IHT from April 2027.
- From April 2026, the IHT-free relief for agricultural and business property will be limited to the first ÂŁ1 million of combined agricultural and business assets. Any portion of an estate that exceeds this amount will incur IHT at 20%.
According to the BBC, the government estimates that 10,500 extra estates will pay IHT in the 2027/28 tax year as a result of these changes.
Fortunately, careful estate planning could help you pass on more of your wealth to loved ones, and you could be considering trusts as a potential avenue for this. Keep reading to learn about trusts and find out how they could help you mitigate a potential IHT bill.
A trust allows you to set aside some of your wealth for your beneficiaries
Research by Royal London has revealed that 8 out of 10 financial advisers discuss trusts, but only 3 out of 10 clients follow through.
Understanding what trusts are and how they work could help you appreciate the potential tax benefits of using this often-overlooked estate planning tool.
A trust is a legal arrangement that allows you to ringfence assets – cash, property, insurance policies, or investments – for someone else (a “trustee”) to manage until they are passed on to your chosen beneficiary.
The trustee cannot benefit directly from the trust, but they have a legal duty to look after and manage the assets it contains.
A common use of trusts is to set aside wealth for young children until they are old enough to assume responsibility for it.
5 types of trust to consider
There are many types of trust, each with its own rules and tax implications. Here are five of the most commonly used trusts:
- Bare trust – The simplest type of trust. Beneficiaries become entitled to the trust assets if they are mentally capable and once they reach the age of 16 in Scotland, or 18 in the rest of the UK.
- Discretionary trust – Your nominated trustee(s) can make certain decisions about how to manage and distribute trust assets, such as which beneficiary to pay and how often payments are made.
- Interest in possession trust – The trustee must pass on all trust income to the beneficiary as it arises (minus expenses).
- Accumulation trust – The trustees can make investment decisions to generate income and increase the trust’s capital. They may also be permitted to pay income out.
- Mixed trust – This allows you to combine different types of trust. Each element of the trust is treated in accordance with the tax rules that apply to that type of trust.
It’s important to choose a trust that meets your specific needs as each comes with its own advantages and potential drawbacks. A financial planner can help you explore your options and navigate the potential complexities of setting up a trust.
How trusts could help you to mitigate a potential Inheritance Tax bill
If you place assets in a trust, they technically no longer belong to you. As such, assets in trust are not usually included in your estate for IHT purposes.
That’s why using trusts can be a valuable estate planning strategy – especially in light of recent changes to IHT rules.
What’s more, placing whole of life insurance in a trust could protect any future payouts from IHT and ensure that your loved ones receive this money as quickly as possible. This is because life insurance generally pays out directly to the beneficiaries and these payments will usually sit outside your estate for IHT purposes.
However, while using trusts could help mitigate the IHT your beneficiaries pay, this does not mean that any trust assets will always be passed on “tax-free”.
Depending on the type of trust you set up, you may have to pay:
- 20% IHT when setting up the trust – You’ll usually pay this charge on any assets you transfer into a trust that exceed the nil-rate band, which is £325,000 for the 2024/25 tax year.
- 6% IHT on each 10-year anniversary – Assets held in a trust must be re-valued each decade and you’ll usually pay 6% IHT on any amount that exceeds the nil-rate band.
- Up to 6% tax when the trust is closed or if assets are removed – The IHT due will be calculated based on the most recent 10-year valuation and charged on a pro-rata basis.
Additionally, if you die within seven years of placing assets in a trust, your beneficiaries will normally have to pay IHT at the full rate of 40% (in some instances, taper relief could potentially reduce this rate).
It’s also worth noting that your beneficiaries will usually have to pay Income Tax at their marginal rate on any funds they receive from the trust.
A financial planner can help you include trusts in your estate plan
As you can see, the rules around trusts are complex. So, if you’re revising your estate plan to mitigate recent changes in IHT rules, you might benefit from speaking to a financial planner who can help you:
- Understand the different types of trust available
- Choose a trust that meets your specific needs
- Decide which assets to place in trust
- Navigate the rules for setting up a trust
- Communicate your intentions with loved ones.
If you’d like to find out more about using trusts to mitigate IHT and pass on more of your wealth to loved ones, we can help.
Please get in touch by emailing info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can assist you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, or trusts.
Note that life insurance plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
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