When the 6th Duke of Westminster died this month, his son Hugh Richard Louis Grosvenor took on not just his father’s title but also an inheritance estimated at £9bn. Under conventional inheritance tax rules (IHT), this could have resulted in a £3bn bill for the 25-year-old, a figure not far removed from the entire death duty take by the government for the last financial year. Instead, he avoids the sizeable bill because the estate is held in a trust structure set up in the 1950s.
Long seen as the preserve of the wealthy – and criticised as a way for families to pass huge fortunes through generations by avoiding death duties – renewed interest has now been placed on trusts and future tax planning.
Part of the planning for the Grosvenor family has involved listing successive generations as “trustees” rather than direct owners of the estate. This means assets do not form part of somebody’s estates for IHT purposes.
IHT is normally charged at 40% on an individual’s directly-owned assets over the “nil-rate band”. This threshold currently stands at £325,000 for an individual, or £650,000 for a husband and wife or civil partners.
Thanks to some careful tax planning, the duke’s estate is likely to pay only a fraction of the £3bn-plus bill it would have owed. But while decades of professional tax expertise have protected the Grosvenor family fortune from the taxman, can the same strategies be used by more ordinary people to stave off death duties?
Just for the wealthy?
Trusts have long been associated with the wealthy who have, for many decades, exploited legal loopholes to find a way round IHT issues. But tax experts say they are not just for the super-rich.
“Anyone can set one up,” says Gary Smith of financial advisers Tilney. “Trusts are a legitimate part of financial planning. Ordinary people will use them to place assets outside their estate for IHT purposes. If you have assets which exceed the £325,000 nil-rate band (or £650,000 for a couple), you can set up a trust to pass assets down the generations without IHT being incurred.” No minimum amount is required to set one up. “You could set up a trust with just £1 or £10,000,” say Smith. “You don’t need to have millions to put away.”
If you put assets in a trust you need to survive seven years for them to move entirely out of your estate for IHT purposes. “If you are thinking about a trust, you need to be aware that you are effectively giving money away, as the trust can’t be unravelled and the money returned to you,” Smith warns.
At the same time, while you may like the sound of the structures used by the Grosvenor family, you need to be aware that the rules on trusts have changed a lot over the years.
“The rules in place in the 1950s are likely to be hugely different from the rules now,” says Chas Roy-Chowdhury from the Association of Chartered Certified Accountants. “You also need to remember that the government is coming down very hard on tax avoidance, so ensure you abide by the rules.”
Using a trust
Aside from using a trust to stave off death duties, there are a number of other family situations where they may be useful.
“A lot of middle-class people use trusts to protect the interests of family members,” says Clive Gawthorpe from accountancy firm, UHY Hacker Young. “Families will appoint trustees to manage assets on their behalf. This can have both practical and tax advantages. For example, if you have a disabled child who cannot manage their own money, you may want to nominate a trustee to manage assets on their behalf.”
Another increasingly common reason to set up a trust is to protect children from previous marriages.
“If, for example, a man gets divorced and remarries a new partner, and the couple buy a home together, he might want to set up a trust to ensure the children from his first marriage get a share of the marital home once the spouse dies,” says Smith. “A trust is a way of ensuring that assets go to the correct beneficiaries.”
In addition, a trust can be used to stop children from cashing in on their inheritance too soon. This may be useful if the recipient is under 18.
Types of trust
■ A discretionary trust is the most common form and has been widely used in the past to minimise IHT. When setting up such a trust, you can name a list of potential beneficiaries. The trustees can then use their discretion to decide who benefits, how much each one receives, and at what age.
You have to pay an immediate IHT charge of 20% of the value of assets going in if the value is above the nil-rate band of £325,000; below this threshold, there is no initial IHT to pay.
The seven-year rule also applies, but in addition there is also a test every 10 years. “This takes place on the anniversary of the creation of the trust,” says Gawthorpe. “It can involve a tax of up to 6% of the value of the trust going to HM Revenue & Customs.”
■ An absolute – or bare – trust is set up in a child’s name and cannot be altered; only one person will ultimately benefit. Bare trusts can often be popular with grandparents wanting to leave assets to younger generations but can result in problems. “For example, a grandparent may put away £100,000 for a grandchild, and that child will become absolutely entitled to that money once they turn 18,” says Smith. “They could then decide to blow the lot on a flash car – and the grandparents have no control over this.”
With an absolute trust, there is no limit on the amount that can be put in, and no immediate tax is payable when the assets go in.
“If you survive for seven years, the assets fall outside of the estate for IHT purposes,” adds Smith.
The costs
In many cases, trusts can be set up simply at little or no charge. “When you set up a trust through a life office, such as Standard Life or Clerical Medical, they will provide ‘trust wording’ for free,” says Smith.
If you are saving a large amount of money, or need to add complicated conditions, you might need a solicitor to draw up the trust. This could mean a fee of between £500 and £1,500.
“Running costs should be minimal if you use family trustees,” says Gawthorpe. “But things could become more expensive if you employ professional trustees.”
Also remember that if you set up a discretionary trust, you may need to do an annual tax return and factor in accountant’s fees. Equally, it is important to seek professional advice because the rules are complicated.
Covering the children
George Martin and his wife Celia (we’ve changed their names), both 59, recently set up a discretionary trust as part of their inheritance tax planning.
“We wanted to ensure our children benefitted from our assets,” says George, who lives near Chester. “We placed two properties into the trust without paying any capital gains tax. While we currently pay tax at 40% on the income, our children will pay no tax as they have no other income.
“Under current legislation, we hope that the properties will be able to be passed out of the trust and on to our children in a few years’ time, with a substantial saving in IHT, perhaps as much as £260,000. There was only a charge of £720 to set up this trust.”
Controversy
Tax campaigners want reforms to the system of trusts which has allowed Britain’s wealthiest families to preserve fortunes through generations by avoiding death duties.
Pressure groups have called on the government to publish its new central register of trusts, which names their beneficiaries and settlers. They want an obligation to publish annual accounts for those collections of assets deemed to have public interest – such as the thousands of acres of urban and rural land owned by the Grosvenor family.
Ways to cut an inheritance tax bill
■ In each tax year you can make a gift up to the annual exemption of £3,000. On top of this, any unused exemption from the previous tax year can also be used, meaning up to £12,000 per couple.
■ Gifts of up to £250 can also be made to as many people as you like, free of inheritance tax.
■ Money can be given to children and grandchildren when they get married. You can give up to £5,000 to a child and up to £2,500 to a grandchild.
■ You can reduce the impact of IHT on your estate by using a life assurance policy written in trust. The death benefit of the policy is used to meet all or part of the IHT due, thus preserving the estate.
■ If held for at least two years, certain assets qualify for 100% “business property relief” from IHT. These include qualifying shares in unquoted trading companies, and some listed on Alternative Investment Market. AIM shares can now also be purchased in Isas, providing the potential for an IHT-free Isa account. Enterprise Investment Schemes enjoy similar IHT breaks to qualifying AIM shares.
Tips provided by Hargreaves Lansdown
