Trusts - your questions answered
The Chancellor's tax changes on trusts set up for widows and orphans have left many people wondering whether they need to rewrite their wills. These are the implications
What is a trust?
A trust allows you to pass money to your heirs while protecting it from tax and keeping some control over how the money is used. The person making the gift can impose restrictions, such as when the money is released and how it can be spent.
Why set one up?
To make sure your heirs get the maximum amount of money free from inheritance tax (
IHT). This tax is charged at 40 per cent on all assets in an estate above a nil-rate band, which currently stands at £285,000.
So a £485,000 estate would face inheritance tax on the top £200,000; at 40 per cent this would mean an £80,000 bill!
A couple could avoid this by setting up a nil-rate band trust which would take £285,000 when the first of them dies. The surviving spouse could take an income from that trust but it would not form part of their estate. When the second person dies, the proceeds of the trust are distributed to their beneficiaries (including children) and they avoid IHT.
Are there any other reasons for doing it?
To control how money is spent and when your heirs receive it.
For instance, an accumulation and maintenance (A&M) trust could be used by grandparents to pay school fees for their grandchildren. When the children turn 25, they inherit any remaining capital and, as long as the grandparents have lived for seven years since setting up the trust, there is no IHT to pay.
Parents might set up trusts in their wills to ensure their children are cared for if both parents die. They could stipulate who has control over the money, what it can be used for and when it is paid out. Commonly, it might be held in trust until the offspring are 25.
Another situation involves an interest-in-possession trust. This might allow a widow to draw an income from money in the trust, but the capital goes to the children when she dies. It could be used by someone who has married for a second time and wants his second wife to be financially secure while ensuring the children of his first marriage eventually inherit.
What changed in the Budget?
Some trusts have been hit by a new tax charge. Anything put into an A&M trust over the nil-rate band of £285,000 during your lifetime is subject to a 20 per cent IHT charge. Then there is a further charge of up to 6 per cent on everything over the nil-rate band every 10 years, and another tax charge of up to 6 per cent on everything over the nil-rate band when the trust finally pays out.
These charges can be avoided if the money goes into a bare trust, which means the children have to get it at 18.
Interest-in-possession trusts could be hit by a 40 per cent inheritance tax on everything over the nil-rate band when the money goes in, even if it's for your spouse, plus a further charge of up to 6 per cent every 10 years,This is the first time for more than 30 years that transfers between spouses can be affected. These taxes can be avoided only under very strict conditions, and trust experts are lobbying hard against these rule changes.
Who will be affected?
The Treasury says just 20,000 people will be affected. But insurers, solicitors and accountants claim many more could be hit. The scenario which might worry most people is that if both parents die, their children will have to inherit when they are 18 rather than the money being locked away until they reach 25.
Can we avoid the new taxes?
You could change the terms of a trust before April 2008 to allow children to inherit when they are 18. Grandparents considering setting up A&M trusts could put off the pain by moving only £285,000 into the trust to avoid the living IHT charge. That would be £570,000 for a couple. |
