Careful planning probably saved the Grosvenor family £3bn in inheritance tax (IHT) when the Duke of Westminster died last month. Most of the family’s assets are held in trust, which allow them to pass between generations without being subject to IHT. There is nothing to stop other people using the same approach – but the rules are no longer so forgiving as when the Grosvenor trusts were set up.
A trust is simply a legal arrangement where assets are held by trustees on behalf of one or more beneficiaries. If you transfer assets into a trust, you no longer own or control them and they are not part of your estate for IHT purposes. Trusts come in different forms, but for IHT planning a discretionary trust is the most popular option because it’s flexible (trustees have full discretion over how they distribute income from the trust).
However, while your heirs won’t have to pay IHT on your assets if you’ve moved them into a discretionary trust, such transfers usually now attract a 20% tax charge straightaway if they’re worth more than the annual inheritance tax exemption (£325,000 in 2016-2017).
This didn’t apply to trusts set up before 2006, so the Duke of Westminster’s family would not have been affected. As inheritance tax is payable at 40%, moving assets to a discretionary trust may still be tax-efficient. However, the trust will have to pay a charge of up to 6% of the value of its assets every ten years – another rule introduced in 2006 that made trusts less attractive for IHT purposes than they used to be.
That underlines an important point about tax planning: as governments can – and often do – change the rules, what works well today may not always do so in the future. You also need to factor in set-up charges, which could be several hundred pounds.
Then there’s the fact that tax changes coming into effect over the next few years mean few people will pay inheritance tax: by 2020-2021 the annual inheritance-tax exemption will be worth £500,000 per person, taking into account extra relief on the value of your house, or £1m for a couple. So, overall, there are better ways for most people to reduce IHT than trusts.
Five ways to plan your inheritance
The potential complexities and expense of using trusts to mitigate IHT are unnecessary for most people, as there are many more straightforward options to consider first.
• Use the annual exemption rules to make gifts – by giving away your assets before your death, you’ll reduce the eventual value of your estate. You can make as many gifts as you like of up to £250 each year with no inheritance-tax implications, as well as larger gifts totalling up to £3,000. You can also gift up to £5,000 to your children, or £2,500 to your grandchildren when they get married.
• Use the potentially exempt transfer (PET) rules. Gifts that are not automatically exempt will not be subject to IHT if you live at least seven years after making them. These gifts can be of any size.
• Make gifts from income. You can make gifts from surplus income with no liability to IHT as long as you’re not reducing your own standard of living and you’re not drawing down capital (although the tax man will often scrutinise these claims very closely).
• Exploit tax reliefs. Several types of investments, including shares in unquoted companies or those listed on Aim, holdings in enterprise investment schemes, and agricultural property are excluded from inheritance tax once you’ve held them for at least two years (seven years for agricultural property if you don’t farm it yourself).
• Use your pension. Assets held in personal pensions aren’t normally subject to IHT, though your heirs might have to pay income tax, depending
on how old you are when you die. That makes pension schemes – particularly those operated through an income-drawdown arrangement in retirement – useful for IHT planning.