Choosing a Trust Type for Inheritance Tax - Step by Step

Inheritance Tax (IHT) is uniquely unpopular. Initially designed to break up the estates of the super-rich, it has failed to evolve as circumstances have changed. As a result, a vast and increasing number of householders now find themselves caught by the so-called ‘death tax’. As property prices begin to rise again, the importance of avoiding Inheritance Tax will continue to increase.

There are several means by which individuals can avoid or mitigate an Inheritance Tax bill. For example, you might choose to gift some of your assets in advance, in order to reduce the size of your estate. One of the most efficient means of avoiding Inheritance Tax, though, is to set up a trust. The basic principle of this arrangement is that you legally separate yourself from some of your assets, in order to reduce the degree to which the value of your estate creeps above the Inheritance Tax threshold. But how do you choose the right trust type for avoiding Inheritance Tax?

Do you need a trust?

Married couples and those in civil partnerships can now pass assets to each other without incurring an IHT levy. Thanks to a recent change in the law, spouses or civil partners can combine their Nil-Rate Bands (the amount that can be passed on without incurring IHT). So, if you are married or in a civil partnership, and the total value of your estate is less than twice the Nil-Rate Band for that tax year, you have no need for a trust at this time – but remember that the surviving spouse may need to set up a trust in order to avoid their beneficiaries paying IHT.

Testament or settlement?

If your circumstances dictate that you do require a trust, you must decide whether to establish it while you are living, or upon your death. If you set up a trust while you are living you are able to see your beneficiaries enjoy the assets that you pass on (known as a settlement). This is only worthwhile if you wish to give away more than your annual gifting allowance; this is currently set at £3,000.

Discretionary trusts can be established very easily, and pro forma trust deeds (the document required to set one up) are readily available. You should, however, always consider seeking legal advice – particularly if the amount you are settling is very large or your affairs are particularly complex.

More common, though, is for individuals to make use of testamentary trusts. This means that the trust is established upon the death of the individual in question. It is outlined in the individual’s will, and is considered to have come into force upon their death. This trust type is particularly beneficial if you wish to retain control of your assets throughout your life – and is therefore the obvious choice if your most valuable asset is your home.

Again, it is possible to draw up the documents to establish a testamentary trust without any legal assistance. But you should remember that trusts are potentially complex legal instruments, and failure to carry out the process properly will have significant repercussions for your beneficiaries. As such, you should always consider seeking professional help.