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Using A Discretionary Trust For Asset Protection And IHT Planning

March 19, 2016

Advice on asset protection for property investors from Optimise Accountants

By Simon Misiewicz

Are you concerned about inheritance tax (IHT)? Do you wish to protect your family assets for your children?

The problem – IHT can wipe out 40% of your family assets

If you are not careful you could spend your life building up assets for your children and yet they’d end up having to give 40% of that away to pay HMRC tax demands. It gets more complicated if the assets you own are properties, as the beneficiaries of the estate will need to sell these properties to get the money to pay HMRC. This is not a fun job, especially when you have lost someone important to you.

Hopefully, by the time IHT becomes an issue for you and your children, the allowance for each parent will be £500,000 (2020/2021) and if they were married and assets passed to one another then the IHT allowance will have increased to £1,000,000. Anything above this amount is taxed at 40%.

You may have the following requirements for your assets:

  • To have income still to come to you
  • To pass assets to the child free from capital gains tax (CGT) and IHT
  • To protect assets from poor decisions that your children might make in their youth

An example of the last point could include your child getting married to the wrong person. By the time they realise their mistake, the inherited assets will be divided unfairly with a person who perhaps brought nothing to the table. Of course relationships are not about money, but when you think about family planning there is a lot to be said for protecting those assets so they’ll always belong to your own family.

The solution – put your assets in a discretionary trust

A trust is a way of managing assets (money, investments, land or buildings) for people. Some reasons people may set up a trust are as follows:

  • to control and protect family assets
  • to keep them safe from someone who is too young to handle their affairs
  • to pass on assets while you’re still alive
  • to pass on assets when you die (a ‘will trust’)

Trusts involve three different types of people:

  • the ‘settlor’ – the person who puts assets into a trust and decides how the asset is to be managed
  • the ‘trustee’ – the person who manages the trust based on the ‘settlor’s’ wishes
  • the ‘beneficiary’ – the person who benefits from the trust

The ‘trustee’ can become a very good ally when safeguarding the future of family assets as they will have final say over the decisions that children/parents make on those assets. This is a very good thing when you have young adults in the family, who can make rash decisions they may later come to regret.

The ‘settlor’ may also be the ‘beneficiary’.

Trustees can decide:

  • what gets paid out (income or capital)
  • which beneficiary to make payments to
  • how often payments are made
  • any conditions to impose on the beneficiaries

As an example you can decide that your child does not receive any benefit from the asset until they meet certain circumstances such as:

  • Must be working and earning £X salary per year
  • Must have obtained certain qualifications
  • Must be of a certain age
  • Must be married and have children

You could also set up a discretionary trust to make sure you yourself have money in the future. You’re the ‘settlor’ but you may also benefit from the trust because the trustees can make payments to you.

The costs incurred by trustees as part of their duties are called ‘trust management expenses’. These expenses may reduce the amount that is taxed at the special trusts rates for accumulation and discretionary trusts of tax due on a beneficiary’s income from an interest in possession trust.

The taxes you need to be aware of

  • Income tax: tax on income from the trust is paid by the trustees, but the ‘settlor’ is responsible for it.
  • Non-savings income, such as rental income etc, is charged at a flat rate of 45%. Bank or building society interest or interest on gilts, etc, is also charged at the flat rate of 45%. Dividends received by a discretionary trust are charged at 37.5%.
  • Capital gains tax:  tax on the profit (‘gain’) when something (an ‘asset’) that has increased in value is taken out or put into a trust. CGT relief is often half of what you get as an individual. The CGT rate for trustees is 28%. The chargeable gain would be calculated by establishing the market value of the asset, as at the date of the trust’s creation, and then deducting the settlor’s acquisition value, any applicable reliefs and any annual exemption available to the ‘settlor’.
  • Inheritance tax is due when:
    • assets are transferred into a trust
    • a trust reaches a 10-year anniversary of when it was set up (there are 10-yearly IHT charges)
    • assets are transferred out of a trust (known as ‘exit charges’) or the trust ends
    • someone dies and a trust is involved when sorting out their estate

Please note that any tax paid by the trust may be claimed back by the beneficiaries if too much tax has been charged by using the R40 form

If you transfer assets into a trust up to your ‘Potentially Exempt Transfer‘ level, which is the same value as the IHT threshold for each individual, and survive seven years then no IHT is payable.

If you die within seven years of making a transfer into a trust your estate will have to pay inheritance tax at the full amount of 40%.

Provided the ‘settlor’ has not retained an interest under the terms of the trust, the property settled will not be treated as being included in anyone’s estate. As they offer flexibility, discretionary trusts continue to be a useful tool in estate planning.

If you make a gift into any type of trust but continue to benefit from the gift — for example, you give away your house but continue to live in it — you will pay 20% on the transfer and the gift will still count as part of your estate. These are known as gifts ‘with reservation of benefit’ within a trust environement.

This creates a situation where there are two possible inheritance tax charges if you die:

  • a charge when you transfer the gift into a trust
  • a charge to your estate when you die — because the asset is still considered part of your estate

To avoid double taxation, only the higher of these charges is applied, in other words you won’t ever pay more than 40% inheritance tax.

Paying for your child’s education

Discretionary trusts are practical where minor children are the beneficiaries of the trust. This is because the trust income can be left on trust to accumulate when the children are too young to receive the money. Once the children are older, trust income can be distributed to them, for example, to pay for their education.

Next steps

If you want to understand how to implement this strategy or to discuss other finance/tax questions then please book some time with us using the below calendar:

If you are looking for a new accountant then please book some time with us using the below calendar. Please note that this booking is to describe our services and will not be used to discuss your personal tax affairs.



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Telephone: 0115 939 4606
Email: simon@optimiseaccountants.co.uk