Gifting Wealth Through a Trust

If you are considering passing wealth to the younger generations, you may wish to consider a trust, which is a tax efficient vehicle when structured correctly.

This type of gifting works well for grandparents wishing to benefit grandchildren. This is not recommended for parents gifting to minor children due to anti avoidance rules that make this type of gifting ineffective for tax planning purposes.

This article focuses on the use of a discretionary trust. Whilst similar results can be reached through a bare trust, this type of arrangement would mean the beneficiary is able to call on the assets when reach the age of 18, when they are perhaps not yet mature enough to hold assets in their own right. A discretionary trust ensures that the trustees control the trust assets until they can be passed to the beneficiaries, when appropriate, at the trustees discretion. Alternatively, the assets can be kept within the trust and used to benefit future generations.

Discretionary trusts for children are commonly used to fund school fees in a tax efficient manner but may also be used later in life for university fees, housing deposits or starting a business. It is important to note that following any gift, the transferor cannot benefit from the trust property as this would be considered a gift with reservation of benefit which would render the gift ineffective for tax planning purposes. The transferor must therefore be prepared to relinquish any future benefit from the asset(s) in full.

There are various taxes to consider when gifting to a trust.

Individuals are entitled to a nil rate band (NRB) of £325,000 and, provided the transferor has not made other chargeable transfers in the 7 years prior to the gift, the trust will receive its own NRB of £325,000. Therefore, a married couple could create a trust valued up to £650,000 with no IHT due and provided the transferor survives 7 years from the gift, this transfer will fall outside of the transferor’s estate.

Assuming the transferor survives 7 years, this creates an IHT saving of £130,000 or £260,000 for a couple. After 7 years the transferor’s NRB is fully restored and available to use against the death estate or, if appropriate, the process could be repeated.

As an example, if an individual were to start gifting at age 50, they could potentially create 3 discretionary trusts of £325,000, removing a total of £975,000 from their estate and saving IHT of £390,000 (or £780,000 for a couple). By the age of 71, the NRB is fully restored. Of course, this assumes the tax legislation remains unchanged during this time, however, as illustrated above, even one trust creates a substantial IHT saving. 

It is possible to gift assets valued in excess of the NRB but the excess value will be taxed at the IHT lifetime rate of 20%. It is therefore much more common to limit gifts to £325k.

Within the trust, the assets are subject to IHT, however this is limited to 6% of the asset growth every 10 years compared with the current 40% death rate.

Capital gains on any gifts to a discretionary trust can be deferred until a future disposal by the trust using holdover relief.

Income arising to a discretionary trust is subject to income tax at the rates applicable to trusts.

However, where income is distributed it is paid with a tax credit of 45% and, assuming the beneficiary pays tax at a lower rate, they will be able to offset this credit against tax due on their other income or claim a repayment. This works well for minor beneficiaries who have a full personal allowance available.

For example, a distribution of £6,500 would be grossed up to £11,818 and as this falls within the current personal allowance of £12,570, the beneficiary could claim a tax repayment of £5,318. They therefore receive the full £11,818 free of tax.

This is just a snapshot but, as you can see, it is possible to gift wealth, retain control, save IHT, defer capital gains and distribute income in a tax efficient manner using a discretionary trust.

It should of course be noted that trusts are complex and there are various costs associated with the creation and running of a trust but, when structured correctly and managed efficiently, the savings can outweigh the costs whilst providing the peace of mind the assets gifted are protected.

Please do get in touch if this is something you wish to explore.