Putting assets into trusts can be a sensible way to reduce the liability of inheritance tax, but it is important to make sure that the gifts are not subject to the reservation of benefit rules.
Inheritance tax can be a significant concern and substantial liability for many families. One way to reduce the liability of inheritance tax is to give away assets during your lifetime and thereby reduce the size of your estate, which would otherwise be liable to inheritance tax on your later death.
Giving assets to a trust is a popular and flexible alternative to making outright gifts, but it is important to make sure that the gifts are not subject to the reservation of benefit rules as the intended tax saving will then be lost.
Why make gifts to a Trust?
There are various reasons why people might prefer to put assets into a trust, rather than make large outright gifts. For example:
Loss of control
Once you give an asset away, the recipient can use it however they like. By putting assets in a trust and being a trustee, you have more control over who gets the benefit of the asset, when, and how.
Children are not ready for gifts
A parent may not want to make large outright gifts to their children. Perhaps they are too young or are vulnerable in some other way, which means that it would not be appropriate to give them a substantial sum of money or other valuable assets.
When assets are held in a trust the beneficiaries have no right to them and the trustees can control what the beneficiaries receive and when.
Tax planning for future generations
If your children are financially secure and have estates which will be subject to inheritance tax on their deaths, it can be better from a tax planning perspective to put the assets into a trust. This prevents the value passing into your children’s estate and increasing their inheritance tax liability.
What are the Reservation of Benefit Rules?
By giving assets to a trust, you are taking value out of your estate.
Provided that you survive the gift by seven years and the reservation of benefit rules do not apply, the assets would not be counted as part of your estate for the purposes of calculating the inheritance tax due on your death.
The rules on what constitutes a reservation of benefit are complicated, but in essence, it applies to circumstances where someone has given away an asset but still has some use or benefit of it or retained an interest in the asset that has been given away.
An asset is still counted as part of the person’s estate for inheritance tax purposes for as long as there is a reservation of benefit. When the reservation of benefit ends, the seven year period then begins.
How do the Reservation of Benefit Rules apply to Trusts?
A person reserves a benefit in a trust if they are one of the beneficiaries of the trust or could potentially become a beneficiary. They may not in fact benefit from the trust at all.
We often find that template/off the shelf trust documents provided by trust or insurance companies or trust documents prepared by offshore providers where the rules may be different do not sufficiently exclude the person making the gift to the trust from being able to benefit from it.
As a result, the reservation of benefit rules apply and the value of the assets in the trust will be taken into account when calculating inheritance tax due on the estate of the person who created the trust, even if their gifts into the trust occurred more than seven years before their death. This can result in an unexpected inheritance tax liability, which can unbalance and distort the distributions of the estate.
It is therefore important that trust documents are carefully drafted to make sure that the reservation of benefit rules do not apply.
Whilst it might be tempting to reduce costs by using “free” trust documents sourced from the internet or insurance companies any perceived saving can be lost if the value of the intended inheritance tax saving behind the creation of the trust is lost. We recommend that standard or “off the shelf” trust documents are used with caution and ideally are professionally reviewed to check that they are fit for the intended purpose.
If a parent makes a gift of the ownership of their home to their son but continues to live alone in the property the fact that the parent has reserved a benefit is clear to see. However, the unaltered wording of an “off the shelf” trust may create a reservation of benefit that may not be immediately apparent.
If you have any questions about this or would like to take advantage of our trust review service, please do not hesitate to get in touch with our Private Client team.