Inheritance Tax

Your estate is not subject to IHT on the following:

• Any part of your estate that passes to your spouse provided you are both domiciled in the UK.
• Most gifts made more than seven years before your death.
• Gifts to charities and political parties.
• Wedding gifts to your son/daughter of up to £5,000. This reduces to £2,500 for gifts to another member of your family when they get married.
• Annual gifts of up to £3,000 each tax year. You can also carry forward the pervious year's allowance if unused.
• As many gifts of £250 per person as you wish to make each tax year.
• Gifts from normal expenditure - this means regular gifts to someone out of your taxed income, not capital (e.g. savings).
• Maintenance payments to an ex-spouse/civil partner, dependent relatives and children under 18 or in full-time education.

Provided you give away an asset and retain no interest in it whatsoever (known as a 'gift without reservation') then it will fall outside of your estate provided you live for a further seven years or more.

Mr & Mrs Trying gift their home to their son, Fred, but continue to live there. Because they continue to benefit from the asset HMRC will not view it as a gift for IHT purposes, the home will still be included in their estate.

When you initially make the gift it will be called a 'potentially exempt transfer' (PET). This means that some of the gift could remain subject to IHT (on a sliding scale known as 'taper relief') if you die within seven years.

Taper Relief rates are as follows:

A often overlooked issue is that when you die PETs are offset against your nil rate band before the rest of your estate. This means that unless the sum of the gifts you make over the seven years before you die is greater than the nil rate band, currently £325,000, then there's unlikely to be any IHT benefit.

This is the document that creates the trust. It contains details of who is setting up the trust, who's responsible for looking after it and who stands to benefit, along with more general details about the trust.

The settlor is the person who creates the trust by gifting money or assets into it.

Trustees are legally responsible for ensuring the trust is run and managed in accordance with the trust deed. A settlor may also be a trustee.

Beneficiaries are the person(s) entitled to receive benefits from the trust, e.g. a grandchild who'll receive some money when they're 25.

Although not technically a trust term, making a potentially exempt transfer (PET) is the usual reason for gifting assets into a trust, so we'll recap quickly (more details on PETs in the 'give away your assets' section towards the top of this page).

If you give away an asset and retain no further interest in it then, provided you live for a further seven years, it's deemed to have fallen outside of your estate for IHT purposes. When the gift is made it's known as a PET. Gifting assets into a trust allows you start the seven year (PET) clock ticking while still retaining some control over the assets.

However, tax changes in 2006 have made it far less attractive to use certain trusts for IHT avoidance if you're gifting in excess of the nil rate band.

This is the simplest type of trust. The settlor gifts assets into the trust and the beneficiary has 'absolute' entitlement to the assets. They're held in the name of the trustee until the beneficiary reaches age 18, at which point the assets pass to them. The beneficiary is liable to any income or capital gains tax that might be due on the assets while they're held in the trust.

Basically, once the assets have been placed into the trust then nothing can be changed, so it's a very rigid one-way process.

This is a popular trust with grandparents who wish to give money to a grandchild but doesn't want them to receive it until they reach age 18. The money is treated as a gift (hence regarded as a PET) and although the child is liable to tax on the interest received they're probably a non-taxpayer so this isn't an issue. Most banks and building societies offer a free form allowing a bare trust to be set up in conjunction with one of their savings accounts (as do a few investment trust managers).

This type of trust is designed to let the settlor gift assets into the trust (i.e. a PET) and for beneficiaries to receive income (and use the asset if relevant) for the rest of their lives. The trustees are responsible for looking after the assets and ensuring income is paid. The trust pays tax on income and capital gains, the beneficiary must pay any further tax due on the income they receive (they can credit tax already paid by the trust if relevant). The trust can be set up so that the assets pass to beneficiaries (not necessarily the one(s) receiving the income) at some point in future (often on the death of the beneficiary receiving the income).

A typical example is a settlor gifting shares they own into an interest in possession trust to move them out of his/her estate (as a PET), but wanting their spouse to receive the income from the shares for the rest of their lives, after which the shares pass to a son/daughter.

Note: transfers into an interest in possession trust greater than the nil rate band are taxed at 20% (classed as a 'chargeable lifetime transfer'), following by a further tax ('periodic charge') of 6% every 10 years. Capital paid out between periodic charges is effectively taxed on a pro-rata basis as an 'exit charge'.

Discretionary trusts are a very flexible type of trust. Once the settlor has gifted assets into the trust (i.e. a PET) then the trustees can decide how much and how often beneficiaries should receive money from the trust and they can also impose conditions on beneficiaries as to when they'll get money. Although trustees should manage the trust in accordance with settlor's wishes, they have considerable power over the trust's assets. It's therefore very important for a settlor to choose trustees they can trust. The trust pays tax on income and capital gains, the beneficiary must pay any further tax due on the income they receive (they can credit tax already paid by the trust if relevant).

For example, a settlor might place £200,000 into a discretionary trust for the benefit of four grandchildren, with an intended term of 20 years. The trustees are responsible for investing the money to meet the trust objectives of providing some money on an ad-hoc basis for each child to help them through schooling (as the trustees see fit) and a lump sum for each child when the trust is wound up after 20 years.

Note: transfers into a discretionary trust greater than the nil rate band are taxed at 20% (classed as a 'chargeable lifetime transfer'), following by a further tax ('periodic charge') of 6% every 10 years. Capital paid out between periodic charges is effectively taxed on a pro-rata basis as an 'exit charge'.

Accumulation & maintenance trusts are a specific type of discretionary trust designed to hold assets on behalf of children under the age of 25.

Once the settlor has gifted assets into the trust (i.e. a PET) the trustees can pay sufficient income to the beneficiaries, who must be under age 25, to ensure they're provided for financially. At the same time any surplus income and investment growth can be accumulated to build up a nest egg for the beneficiaries, to be paid out to them between age 18 - 25, as stipulated by the trust. The trust pays tax on income and capital gains, beneficiaries must pay any further tax due on the income they receive (they can credit tax already paid by the trust if relevant).

Note: transfers into an accumulation & maintenance trust greater than the nil rate band are taxed at 20% (classed as a 'chargeable lifetime transfer'), following by a further tax ('periodic charge') of 6% every 10 years. Capital paid out between periodic charges is effectively taxed on a pro-rata basis as an 'exit charge'.

This is a type of discretionary trust whereby the settlor makes an interest free loan to the trust that is invested by the trustees. This loan remains in the settlor's estate, so is no use for IHT planning, but any growth within the trust is deemed to be outside of the settlor's estate - this is the potential IHT benefit. The trust assets are typically passed to beneficiaries on the settlor's death.

The settlor can request loan repayments at any time, although the more they withdraw the less scope for capital growth outside of their estate. The trust pays tax on income and capital gains, beneficiaries must pay any further tax due on the income they receive (they can credit tax already paid by the trust if relevant).

These types of trust are mostly sold by insurance companies, using their investment bonds as the underlying investment. Given these investment bonds can pay very high commissions to financial advisers, be wary. They're not necessarily a bad idea, but commission could lead to inappropriate advice being given.

Note: There's no risk of 'chargeable lifetime transfer' tax initially because the settlor is not gifting any assets into the trust, it's a loan. A 'periodic charge' of 6% may apply after 10 years (and every 10 years thereafter) if the value of the trust exceeds the nil rate band (any outstanding loan is deducted from the overall trust value). Capital paid out between periodic charges is effectively taxed on a pro-rata basis as an 'exit charge'.

This is a specific type of discretionary trust that allows the settlor to gift assets into the trust and enjoy an immediate reduction in the value of their estate as well as regular withdrawals (effectively an income) for the rest of their lives. The trustees role is as per discretionary trusts and beneficiaries might usually expect to receive the trust's assets when the settlor dies, depending on the settlor's wishes.

Because the settlor is entitled to regular withdrawals, the part of the gift that is earmarked to pay these withdrawals (the 'discount') is not treated as a gift for IHT purposes, hence it reduces the size of the settlor's estate. The size of the 'discount' increases the more you withdraw and/or the longer your life expectancy. The trust pays tax on income and capital gains, beneficiaries must pay any further tax due on the income they receive (they can credit tax already paid by the trust if relevant).

These types of trust are mostly sold by insurance companies, using their investment bonds as the underlying investment. Given these investment bonds can pay very high commissions to financial advisers, be wary. They're not necessarily a bad idea, but commission could lead to inappropriate advice being given.

Note: transfers into a discounted gift trust greater than the nil rate band (after the 'discount') are taxed at 20% (classed as a 'chargeable lifetime transfer'), following by a further tax ('periodic charge') of 6% every 10 years. Capital paid out between periodic charges is effectively taxed on a pro-rata basis as an 'exit charge'.