Inheritance Tax & Trusts – What You Need To Know

Anyone who holds property in the UK could potentially be subject to UK IHT on death, at a rate of 40%. This now includes those who are non-UK-domiciled but invest in the UK through an offshore structure, known as enveloping.

The added IHT sting, which is less well known, is that UK expats may also be liable to UK IHT on their worldwide property, outside the UK, if HM Revenue & Customs deems them to be UK-domiciled.

Often UK expats believe they are no longer UK-domiciled when they leave the country for a long period of time, but that might not be the case. Losing a UK domicile status is very complex and often is not confirmed until someone passes away.

Putting plans in place to make sure assets are passed on tax efficiently is a key step for all those who might be caught by UK IHT.

Psychological barrier

However, often clients face a psychological barrier when it comes to IHT planning. They want the comfort of stipulating who will receive what assets and when; they like to know assets are being passed on tax efficiently but don’t like the thought of giving up control and ownership of the assets. This creates a dilemma between having access to capital while achieving inheritance tax efficiency.

With the increase in life expectancy and growing care costs, it is becoming harder for people to predict what their income requirements might be in later life. A real fear clients may have is giving away too much within a trust and not being able to access any money if their circumstances change.

Consequently, we are seeing growing demand for inheritance tax planning solutions with greater flexibility that can adapt to customer’s changing needs.

Trusts continue to be one of the most effective tools in succession planning but, in order for the trust to help mitigate IHT, the client needs to transfer away legal ownership of the assets.

Trusts you can trust

There are a number of trusts that deliver varying degrees of flexibility.

A discounted gift trust provides the ability to make a gift into a trust but retain a lifelong right to draw an ‘income stream’ from that gift – as long as the trust fund supports this. The value of the future withdrawals is called the ‘discount’, and takes into account factors such as age and state of health. The significance of the discount is that the client’s estate should immediately be reduced by the value of the discount. Any growth on the trust fund is also immediately outside of the estate.

In general, where a client is in good health for their age and below the age of 90, there should be an immediate IHT saving. However, the right to withdrawals is ringfenced at outset and cannot be changed.

As an example this could allow the client (settlor) to determine the future dates when they may require withdrawals, and state the number of policy segments they may wish to access on each of these dates. As they approach each date, the client decides whether or not to take the entitlement.

If the client takes the entitlement the stated policy segments are moved into a bare trust and can be accessed immediately, at a later date, or assigned to a loved one.

There is also flexibility for the trustee to assign policy segments directly to loved ones, for example, to pay for their grandchild’s education. This prevents the money entering the settlor’s estate and the payment of school fees being treated as a (further) potentially exempt transfer.

If the client decides not to take the entitlement, or postpones the entitlement to a later date, the funds stay within the trust, and will continue to be outside of the settlor’s estate for inheritance tax purposes.

A loan trust is a vehicle that allows the client (settlor) access to the capital sum, while any growth on that sum is immediately outside their estate. A loan is made by the client to the trustees of a trust, either discretionary or bare. The trustees use this loan to invest into an investment vehicle, typically a single-premium investment bond.

The loan amount is not deemed a gift, so will continue to form part of the settlor’s estate for IHT purposes, but as the growth is outside of the estate, it effectively caps the IHT bill on day one. Over time, as more money is paid back to the settlor and spent, the less money there will be in their estate for IHT purposes, helping to reduce IHT overtime.

It’s not just about tax

It is important to remember that trusts do not just offer taxation benefits, they can provide a way to navigate complex family situations.

Trusts give people the opportunity to gain greater control over the distribution of wealth on death: a scenario such as the Ilott case, where a woman challenged her mother’s will after it was left entirely to charities, would unlikely occur as the Inheritance Act does not apply to trusts. Plus, distribution of trust assets against the terms of a trust would be a breach and could be legally challenged.

An added bonus is that trusts are confidential so, unlike wills, they do not become public knowledge.

What is the Next Step?

We are able to assist and we will be able to answer any questions you have and advise you on the best way to proceed, in what can be a hugely complex planning area.

Contact us today and one of our experienced advisors will be happy to assist.

About Expat Financial

Expat Financial is a team of highly experienced Hong Kong based Financial Advisors. As Expats ourselves we understand the challenges of living and working in a foreign country. We use our Expat experience along with our extensive financial expertise to help you maximise the benefits of working and living offshore.

Regardless of whether you’re a financial novice or a seasoned investor we specialise in helping you to achieve your goals.

Additional Information Resources

Additional information resources are available by clicking on the links below:

• Financial Planning
• Investments 
• Insurance 
• Pensions
• Tools & Calculators
• News