Using Trusts for Inheritance Tax Planning

Many people believe that trusts are only used by the seriously wealthy, who have complicated financial affairs. However, this is not necessarily the case.

As more of the population see the value of their estates increase, fuelled by the rise in property prices, there is now an even greater need for you to plan for inheritance tax (IHT) and look at your tax affairs. Your inaction could mean a 40% tax bill payable on the value of your estate in excess of the 'nil' rate band (275,000 for 2005/06).

So it is in this area that trusts can come into their own, with many IHT planning packages built around them. So what are the most common trusts?

Absolute Trusts, or Bare Trusts

The beneficiaries are named in the trust deed or will. They have the right to income and capital immediately and, as soon as they are 18, they have the power to demand the contents of the trust from the trustees. The beneficiaries and their shares cannot be changed.

Accumulation and Maintenance Trusts

These are trusts for children. They are discretionary trusts with preferential treatment for inheritance tax purposes. The donor doesn't have to specify exactly what each child will receive. The trustees can dispense money as they see fit for the education, maintenance or benefit of the children. Once the children reach the age of 25, they must at least have the right to income from the trust.

Discretionary Trusts

The trustee has absolute discretion over who benefits from the trust from amongst a class of beneficiaries specified by the settlor. However, a gift into such a trust is immediately chargeable to inheritance tax at 20% if the gift takes the settlor over his or her 'nil' rate band. The Inland Revenue can continue to levy charges every 10 years.

Interest in Possession Trusts

Flexible Power of Appointment. The trustees have discretion over who benefits from the trust, within classes of beneficiary selected by the settlor at the outset. But the income generated by anything in the trust is automatically given to "specified beneficiaries".

Life Interest Trusts

The specified beneficiary is entitled to receive for life the income generated by the trusts' investments, but the capital will pass (on death) to the next set of beneficiaries - possibly children.

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