Discretionary trusts can be highly useful estate planning tools. The effective use of such a trust can ensure that Nil-Rate Band inheritance tax exemptions are used to their full effect; as such they can represent a significant tax saving for an individual’s heirs.
Details regarding the proper use of discretionary trusts are available elsewhere on this site. In basic terms, however, under such an arrangement assets are transferred by the settlor into trust, and the trustees assume the legal title to those assets.
The trustees can then choose when and how much to pay out to each of the beneficiaries; none of the beneficiaries has an absolute right to a payment. The trustees may be guided by a ‘letter of wishes’ provided by the settlor, but this is not a legally binding document.
Income & Capital Gains
The tax treatment of discretionary trusts is comparatively complicated. In the first instance, it is important to remember that there is no tax implication for the settlor. As they give up ownership of their assets, they will not be required to pay income or Capital Gains tax on the trust.
Conversely, as the trustees take on the legal title they will be required to pay income and Capital Gains tax in exactly the same way as they would if they owned the assets as individuals. Income and capital gains are charged at a flat rate of 40%, although reasonable management expenses are deducted before tax. Trustees, like individuals, are entitled to an annual exemption for capital gains, but the exemption available to trustees is considerably lower.
There are also tax implications for the beneficiaries when they eventually receive payment from the trust. Beneficiaries will be required to pay income tax on these payments at their regular rate. However, the tax already paid by trustees will be deducted from this liability. In circumstances in which the trustees have paid more tax than that for which the beneficiary is liable, a rebate will be given to the beneficiary.
Tell us about your circumstances and get a personalised estate planning checklist covering wills, trusts, and inheritance tax.
Try our Estate Planning Checklist free, here on this site →Your situation may be slightly different. ask a question below ↓ and our editorial team will reply with our advice.
Inheritance Tax
It is important to note that, as well as the liabilities listed above, discretionary trusts also have an inheritance tax charge levied every ten years. In most cases, Nil-Rate Band discretionary trusts will escape this charge, but they will otherwise be taxed at a rate of around 6% of the total value of the assets held in trust. Inheritance tax is also charged when assets are disbursed. This charge is not levied at a set rate, but rather depends on how long the assets have been in trust since the last ten year charge; the rate at which they were last subject to inheritance tax; and the value of the assets.
The tax schedule that applies to discretionary trusts is, as can be seen, fairly complex. While these trusts are potentially vital for mitigating an inheritance tax liability, it is important to seek independent financial advice when establishing one. If the trust is established or funded inefficiently it may well be that the trust itself ends up presenting an inheritance tax liability, rather than ensuring a saving.
she only lived 5 1/2 years
no tax was paid at the time it went into trust
solicitors say its full inheritance tax payable and we have paid it but case still open as valuers querying the value of both properties
now ive been told this....
If a discretionary trust was set up in 2009, this would be what is called an immediately chargeable transfer - meaning the property transferred into trust would have been charged to tax at 20 or 25% at the time the trust was created. This lifetime tax would be deductible from any death tax. If the lifetime transfer was within the first £325,000 given away in a 7 year period, there might have been no lifetime tax actually payable in 2009, as the first £325k is taxed, but at 0%. This £325k is called the nil rate band.
What happens next is that if you live 7 years from the date of the gift, no tax is payable on death. If you die within 7 years, some death tax may be payable. If you live for at least 3 years after the date of the gift, HMRC will knock 20% off your tax bill for each year you survive (this is called taper relief). So 3-4 years your bill is 80% of the tax due, 4-5 years 60% and so on.
do you offer any advice on line or by phone or any advice as to where I turn?
thankyou
A discretionary trust has been set up via a Deed of Variation for a sum less than the £325K IHT limit left by a relative to me. In order to gain from the IHT benefits, does the money inherited actually have to be placed in a special named Trust bank account before it can be used by the beneficiaries e.g. by loan or other means. I've been told that unless the money is actually placed in a named and identifiable Trust bank account, then the HMRC may well disallow any claim for tax exemption.
What happens with a vulnerable beneficiary and how does that affect tax and payments of capital from the fund when the trust has been created by an inheritance?
Ask Estates or Trusts a question
Ask our editorial team a question and we will reply with our advice. Tell us as much about your situation as you can: the more detail you give, the more useful our answer can be.
You do not need to use your real name. Please do not include your full address, phone number, email address, or the names of other people. We may edit or remove identifying details for privacy and legal reasons.
Comments are moderated before publication.