Inheritance Tax (IHT) can significantly reduce the wealth passed on to your loved ones. With rising property values and relatively low tax thresholds, more families than ever are being caught by the 40% tax on estates above the nil-rate band.
If you’re looking to reduce your inheritance tax bill, one strategy worth considering is setting up a family trust. But is it the right option for you?
Let’s break it down
What Is a Family Trust?
A trust is a legal arrangement where you (the settlor) transfer assets to trustees, who manage them on behalf of your chosen beneficiaries.
In the case of a family trust, the beneficiaries are usually your children or grandchildren. Trusts can hold money, property, shares, or other assets — and they can be set up while you’re alive (a lifetime trust) or through your will (a testamentary trust).
What Is the 7-Year Rule for Inheritance Tax?
If you give away money, property, or other assets during your lifetime, those gifts may no longer be counted as part of your estate — and therefore not subject to inheritance tax — if you live for at least 7 years after making the gift.
This is known as a Potentially Exempt Transfer (PET).
How It Works
- If you survive 7 years after making a gift, no inheritance tax is due on that gift.
- If you die within 7 years, the gift may be taxed, depending on its size and when it was given.
Taper Relief: Tax Reduces Over Time
If the gift is over the £325,000 nil-rate band and you die within 7 years, taper relief can reduce the tax payable. Here’s how it works:
| Years Between Gift and Death | Inheritance Tax Payable |
|---|---|
| 0–3 years | 40% |
| 3–4 years | 32% |
| 4–5 years | 24% |
| 5–6 years | 16% |
| 6–7 years | 8% |
| 7+ years | 0% |
An example of how inheritance tax works and taper relief
You give your child £500,000.
- If you live more than 7 years, it’s completely exempt from inheritance tax.
- If you die 2 years later, £175,000 (the amount above the £325,000 threshold) could be taxed at 40% = £70,000 tax.
- If you die after 6 years, that £175,000 is taxed at 8% = £14,000 tax.
How Can a Family Trust Help Reduce Inheritance Tax?
When you put assets into a trust, those assets may no longer be considered part of your estate for inheritance tax purposes — depending on how the trust is set up.
Here are a few key benefits:
1. Potential Removal from Your Estate
If you survive for 7 years after placing assets into a trust, the value of those assets may be excluded from your estate, potentially saving 40% in IHT.
2. Control Over How Assets Are Used
You can set rules for how and when beneficiaries receive money — ideal if they’re young, financially inexperienced, or vulnerable.
3. Protecting Family Wealth
Trusts can safeguard assets from divorce, bankruptcy, or reckless spending by future generations.
4. Access to ‘Nil Rate Band’ Planning
Trusts can help make better use of inheritance tax thresholds and allowances, especially when structured alongside wills or gifts.
Important Considerations and Pitfalls
While family trusts can be an effective inheritance tax planning tool, they’re not without complexity. Setting one up requires careful thought, and there are several important factors to consider before making a move. Contact Clayton Stirling & Co for more information on this.
First, trusts come with their own set of tax rules and administrative responsibilities. They must be properly registered with HMRC via the Trust Registration Service, and trustees are legally responsible for managing the trust in line with both tax regulations and the terms of the trust deed. This often involves ongoing paperwork and can require professional help to stay compliant.
There are also potential tax charges to be aware of. If you place more than £325,000 into a trust, you may face an immediate 20% inheritance tax charge, known as a lifetime charge. Additionally, certain trusts are subject to what’s known as the “10-year anniversary charge,” which can apply every decade the trust remains in place, as well as exit charges when assets are distributed.
Another key point is access. Once you transfer assets into a trust, they’re no longer legally yours. That means you can’t simply take them back if your circumstances change. For this reason, trusts are generally better suited to those who are confident they won’t need those funds later in life.
Finally, it’s important to understand that trusts aren’t a magic bullet. Used incorrectly, they can trigger tax liabilities rather than reduce them. That’s why it’s essential to take professional advice before setting one up — to ensure it’s the right structure for your goals, and that it’s done in a way that’s both tax-efficient and legally sound.
