For those unaware, inheritance tax – or IHT – is paid when your estate is worth more than £325,000 (nil rate band). This includes your bank accounts, assets, businesses, property, investments, and any other possessions. The standard IHT rate is 40%, and it applies to your estate after it exceeds the threshold, meaning you are taxed the difference between your valuation and the £325,000 threshold. 

For many people looking to take control of their assets before they pass away, this can obviously become a cause of stress. We all want as much of our finances as possible to go to the beneficiary after death, especially in the current financial climate that we’re living in. 

With the IHT threshold also frozen until 2028, interest rates and the rising average property value have made it even more of a sore point, as millions in the UK are preparing to have their inheritances dramatically scored. 

Trusts As a Solution to IHT

As a trusted financial advisor in Bristol, this is one of the areas of finance that we often assist clients with, but we’ve seen more people than ever stating that a trust is the answer. Many people believe, for instance, that placing your assets into a trust offers a way to bypass the IHT system, as they do not technically belong to the donor or the ‘object’ of the trust. Because of this, a trust does not count toward your estate, and provided you pass away at least seven years after the transfer was made, the value is not counted for IHT purposes.

In many ways, this is true. Under the correct circumstances, a trust is not counted toward IHT. Not only this, but a trust offers plenty of other benefits. For instance, a discretionary trust can provide the payer with flexibility, with the ability to take income over time and even benefit from compound growth. 

A bare trust, on the other hand, can be accessed before a beneficiary turns 18, and is taxed at a child’s marginal rate, meaning the tax on the trust should be very low or even tax-free. That being said, using a trust to bypass IHT is not the magical solution that people believe it to be. 

The Problem With IHT Avoidance

For one thing, it’s worth reiterating that not everyone is subject to IHT. According to government figures, only around 4% of deaths in the UK result in 40% IHT, and this isn’t just because of the people not reaching the threshold. Liability, for instance, increases to £500,000 if you’re leaving a main residential property to descendants. A married couple with direct descendants could therefore have up to £1m in there estate before IHT becomes an issue.

Even if you are above these thresholds, however, setting up a trust can be more costly than people think. For starters, you’ll typically pay tax when setting up a trust in excess of the nil-rate band – the amount to be passed onto beneficiaries without being charged IHT. 

With a discretionary trust, for instance, there can be a 20% tax charge when the tax is set up, and then a 6% charge every 10 years — less the IHT threshold. IHT will also need to be paid again when the trust is closed and the assets are removed, with the amount based on the most recent 10-year valuation – again, up to 6%.

The Real Answer to IHT

We’re not saying that setting up a trust is a bad idea. Quite the opposite, setting up a trust can be a great option for many people. But tax should not be the main reason to set one up, especially if you are planning to do so without independent financial advice. 

Because the details surrounding trusts are vast and complicated, a financial advisor can be the key to perfecting a trust and providing optimal insurance for future generations – which is what trusts are all about.

In terms of IHT, financial advice puts you in a far better position to take advantage of allowances and reliefs. As alluded to in this article, estates can be taxed far less than the threshold suggests, and with professional inheritance planning, you can ensure that as much of your money gets to your descendants in the easiest way possible. 

Not only this, but an advisor can help you explore life insurance plans, ensure your will is correctly drafted, set up a gifting plan, and structure your estate to maximise what you leave and minimise what you’re liable for. 

It’s important to remember that financial roadblocks never have quick-fix solutions. But if you’re looking for the best solutions, advice from a financial expert is always the best way to go.

Please note: Inheritance tax planning, will writing, estate planning and trusts are not regulated by the Financial Conduct Authority (FCA)