The trust that got away
Gordon Brown’s crackdown on trusts has so far missed a scheme that could allow families to save inheritance tax (IHT). The schemes, called discretionary will trusts, are expected to jump in popularity as the number of properties above the IHT threshold — £285,000 this tax year — soars.
Halifax has estimated that the number of properties valued at more than £285,000 could nearly triple from 1.5m this tax year to 4.2m by 2020.
The number of £1m properties is also soaring, which is boosting the Revenue’s inheritance-tax take even further. There are now an estimated 66,600 properties worth at least £1m compared with only 3,400 in 1995.
At the same time, the chancellor has clamped down on ways families can legitimately save inheritance tax. In his March budget, Brown launched a retrospective crackdown on two types of trust — “accumulation and maintenance” and “interest in possession”.
Discretionary will trusts, which enable husbands and wives to make use of both their IHT-free allowances, escaped the crackdown unscathed.
This type of trust allows couples to mitigate or even completely eradicate an IHT liability by taking maximum advantage of the tax-free allowances available to them. It is a straight-forward and cost-effective scheme that is fully compliant in the eyes of the taxman.
Take a married couple with a home worth £570,000. When the husband dies, the house will pass to his wife with no inheritance tax because transfers between spouses are tax free.
When the wife dies, however, her estate will be taxed at 40 per cent on assets above her IHT allowance (also called the nil-rate band) of £285,000 — a tax bill of £114,000 (assuming the house is her only asset).
Alternatively, they could set up a discretionary will trust to make use of both their IHT allowances. They would draft their wills so that on the death of the first spouse, say the husband, assets up to the value of his nil-rate band (£285,000) would pass into a discretionary trust set up for the couple’s heirs. However, to avoid selling the house, the wife would simply owe the trust the £285,000.
When the wife died, the trust would call in the £285,000 loan, which would be deducted from the value of her estate and pass to the couple’s heirs free from IHT.
The remainder of the estate (£285,000) falls within her nil-rate band, so there is no tax to pay — a saving of £114,000.
For this to work, you must own your property as tenants in common, rather than joint tenants. And if you leave assets worth more than the nil-rate band to a discretionary trust, the amount over the threshold would be subject to tax at 40 per cent.
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