The New Inheritance Tax Limit – How It Will Affect Your Discretionary Trust
Due to the goverments Inheritance Tax Limit changes, thousands of families will need to review their wills if they want to reap the benefits
Many families who planned to leave property to their children in a tax-efficient manner via “Discretionary Trusts” will miss out on new inheritance tax allowance unless they update their wills. Discretionary trusts were widely used in the past to minimise inheritance tax (IHT), and they allowed assets to be passed on to loved ones (trustees) to manage on their behalf. They were popular as they allowed for the first spouse’s assets to be removed from an estate for inheritance tax purposes on their death, meaning each spouse’s allowance was utilised. Homes left to children through discretionary trusts will no longer benefit from the “family home allowance”, worth up to £350,000 per couple from 2020, as assets do not pass directly to children.
Why were Discretionary Trusts so popular?
Up to October 2007, if someone were to die, they could leave all of their assets to their surviving spouse completely IHT free. However, when the spouse were to die, they could only use their own tax-free allowance, or “nil-rate band”, for the total estate. This meant that many faced tax charges when passing assets to their children or other beneficiaries after the second death.
What has changed?
In October 2007 the rules changed making discretionary trusts less attractive. Married couples and civil partners could transfer any of their unused nil-rate band to their surviving spouse, creating a tax-free allowance of up to £650,000 on the second death.
Why should I review my Discretionary Trust?
As the rules are changing and the amount available is increasing, it is important to understand how this affects you. The new family home allowance will be available from April 2017 to people who own a home. By 2020 the £325,000 allowance that everyone currently is eligible for, will be increased by £175,000 per person, meaning the new allowance for property owners will be £500,000, or £1m for couples.
Most importantly, to qualify for the family home allowance the property must be directly inherited by direct descendants, such as children, stepchildren, adopted and foster children, and grandchildren. Discretionary trusts will not qualify as the trustees will have the decision over which beneficiaries will receive which assets and when. Nevertheless, some people still use them to ensure assets are left to their intended beneficiaries.
Which Trusts will qualify?
Interest in possession (IIP) trusts
The most common qualifying trust will be an IIP created by a will – this is often seen where the first spouse dies and wants to ensure that the surviving spouse can occupy the property for the duration of their lifetime, before the property passes to children or grandchildren.
Disabled persons trust and IIP
Similar to the above, this is where an IIP is created for the benefit of a disabled beneficiary.
Bereaved minor’s trust
This trust is created for the benefit of a child under the age of 18 who has already suffered the death of one parent. While the child is under 18, he or she should be able to live in the property or, if it is let, should benefit from any income. When the child reaches 18 years of age, legal ownership of the property passes to them.
Age 18 to 25 trusts
This operates in a similar way to the trust above, but the child takes on legal ownership of the property at age 25.
How can we help you with Planning Inheritance Tax? Find out here.