Trust in your family
Estate planning with a twist

Following the Pre-Budget Report the surviving spouse is now able to bequeath up to £600,000 tax-free. By 2010, this figure will increase to £700,000. The new rules also apply to people in civil partnerships. In the current tax year, assets held over the nil rate band for IHT are taxed at 40 per cent. For married couples and civil partnership couples, assets passing to the survivor are not subject to IHT.

As the affects of inheritance tax (IHT) continue to blight an increasing number of individuals, one solution if appropriate, is to consider using a family trust as part of your estate planning. Trusts have long been used as one of the many potential solutions to family financial planning issues, including mitigating an IHT liability. In more recent years however their have been some significant developments and legislative changes in the way trusts are treated in relation to IHT.

A trust is one way of moving money out of a person's estate with the object of reducing an IHT bill. Many different assets can be held in trust, including investments, life insurance policies and pension scheme death benefits.

The value of life insurance policies that are not written in to an appropriate trust, when combined with the value of the family home, can further compound the problem and subject families to an even larger IHT problem. If a life assurance policy is placed into an appropriate trust, when the settlor dies the proceeds become payable to the trust. Provided the premiums were paid out of surplus income or were less than the annual gift exemption of £3,000, IHT is avoided. In addition, as the proceeds are outside the estate, the trustees have access to them without having to wait for probate, allowing the people who should benefit to do so as quickly as possible.

Trusts work by allowing the settlor (the person who establishes the trust), to entrust their assets to a group of people (the trustees). The trustees are the legal owners of the assets and manage and ultimately distribute them for the benefit of the beneficiaries (the people who the settlor wishes to benefit from the trust).

Trusts can also provide people with the peace of mind that their wishes will be carried out and offer a solution to enable them to control their assets, for example, to pass them on to children or grandchildren or withholding assets until children reach a certain age.

All gifts are considered as either chargeable lifetime transfers (CLTs) or potentially exempt transfers (PETs), depending on the type of recipient. The IHT treatment for each is slightly different. The IHT treatment of gifts to most trusts was significantly changed by the Government last year. Previously gifts to most trusts were treated as PETs. However, most are now treated as CLTs and so are subject to entry, exit and ten-yearly tax charges.

With PETs there is no IHT to pay, assuming the person making the transfer lives for seven years following the gift. However, only outright gifts to individuals, or to trusts where the beneficiary is fixed and cannot be changed, qualify for this treatment.

Most other gifts to trusts will now be treated as CLTs and so may be subject to an immediate tax charge, as well as charges every ten years and also when capital is paid to beneficiaries. However, these trusts give families the flexibility to change the beneficiaries of the trust in future.

The main types of trusts likely to be considered by families are:

Absolute trusts (also known as bare trusts). These ensure that a specified person will benefit from the trust. From the outset, each beneficiary has a precisely defined share of the trust property that the trustees or the settlor can never change. Transfers into absolute trusts are treated as PETs.

Discretionary trusts. Unlike the Absolute trust, discretionary trusts offer flexibility. The trustees have complete discretion over when they pay the trust benefits and to whom (from a wide class of beneficiaries) they make payments of income or capital. Transfers into discretionary trusts are treated as CLTs.

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