Justin Taurog discusses case studies that show the value of inheritance tax.
Case study: IHT and trusts in practice
2015
Mr and Mrs James, have three children, Aaron (21), Beatrice (18) and Chris (11). Mr and Mrs James have surplus funds to establish a discretionary trust ('Trust one') with £650,000. Both Mr and Mrs James are trustees. Each is treated as settling £325,000.
2022 (+7 years after Trust one created)
Aaron (28) is now buying a property with his partner. Trust one loans him £200,000 and the trustees also advance £100,000 to Beatrice as a young entrepreneur, double matching her initial investment acquired through savings. £15,000 is used for Chris, the youngest child's university education. Mr and Mrs James then create a second discretionary trust ('Trust two') with a further £325,000 gift each.
2025 (+10 years after Trust one is created)
Trust one reaches its ten year anniversary and the first potential periodic charge. With good capital growth on investments in trust and with the original loan to Aaron still outstanding, the value exceeds the Nil Rate Band and there will be some periodic charge to pay.
2029 (+4 years after last ten year anniversary of Trust one)
The trustees release the loan and advance a further £100,000 funds from Trust one to Aaron who now has a young family to support, also £50,000 to Beatrice to support her flourishing business expansion, paying the required exit charges from the trust. Chris' whirlwind marriage ends in 2027. He is now divorced and receives no distributions.
2031 (+6 years after last ten year anniversary of Trust one)
Chris is now trained as a nurse and settled. Aaron is a successful web designer. Beatrice's expansion paid off and her business is now very successful with seven figure annual profits. The adult children are now established in their chosen careers and settled but having different financial needs and earning potential - the trustees want to use the trust funds for their children and grandchildren's benefit and equalise the differing financial circumstances to some extent:
• Aaron receives the remaining funds in Trust one to help buying bigger house, the trustees pay the exit charge;
• Chris receives 55% of Trust two;
• Beatrice is independently wealthy owning a successful trading company which currently qualifies for Business Property Relief (BPR), she also owns her own property and has some investments and does not want to swell her estate further; and
• The remaining 45% of Trust two is earmarked for the grandchildren's education and also wider family medical needs. The value is below the Nil Rate Band approaching the first ten year anniversary and the first potential periodic charge, therefore no IHT is due.
Mr and Mrs James have reduced their estate by the initial £1.3m capital gifts into the trusts (also additional IHT saving of any future growth on this).
They have been able to use these funds to assist their children establish themselves in life through funding higher education, getting on the property ladder, supporting a strong entrepreneurial vein in the family, while protecting some capital from potential third party claims.
Now grandparents, they still have some funds in Trust two to pay for their grandchildren's future educational needs and also medical needs for wider family should they be unfortunate enough to require it.
On the value of their combined estate there is a potential additional IHT liability of £500,000. This is covered by a Whole of Life joint-life second death policy, which has been written into trust for the benefit of their children and grandchildren ('Trust three').
They fund the premiums using the gifts out of income exemption and also make use of their Annual Exemption paying this into their grandchildren's bank accounts. As this is a joint-life second death policy, they also appoint additional trustees to act with them. This ensures that their chosen trustees can act straight away at claim stage on second death and preserves the speed of payment benefit.
2059
Mr James dies. His estate passes to Mrs James free of IHT under the spouse exemption.
2061
Mrs James dies, the policy pays £500,000 to their chosen trustees of Trust three. The trustees use the funds to enable the children, who are the primary beneficiaries of the couple's estate, to pay the IHT so that they can inherit their entire estate free from IHT. There are also surplus funds for the children to use for their own families.
What next?
There are a number of calculators available that can help estimate what your clients IHT bill could be, and how it can change over time. If they think they might be liable to IHT, then it is important to discuss what their options are in protecting their wealth for their dependants.
Click here to use VitalityLife's IHT calculator
