Chapter: 2 - Inheritance Tax Mitigation: The Basics

The key IHT distinction

2.3.3

Chapter 3 describes the tax-efficient management of existing trusts and Chapter 4 considers the tax implications of making new trusts.  In broad terms, the IHT treatment of a lifetime trust will fall into one of what were two categories before 6 April 2008, but are now just two ((a), and (c) below).  The age 18-to-25 trust (category (d)) is essentially a type of Will trust, although before 6 April 2008 property within the accumulation and maintenance regime coud be converted into such a trust.

(a) The relevant property regime
This applies to discretionary settlements and almost every other type of lifetime settlement made on or after 22 March 2006, except where the beneficiary is disabled (IHTA 1984 s58 and see 3.8.1).

The general principle with such settlements is that at commencement the settlement inherits a cumulative total equal to that of the settlor on the day prior to creation plus the value of other funds settled by the settlor on the day of creation (related settlements). There are then two principal charges:­

(i)  a ten-year anniversary charge, which is applied to the then value of the trust fund, given the initial cumulative total and funds leaving the trust in the preceding ten years (IHTA 1984 s64 and see 3.7.3). This is computed so that over the course of an assumed generation, some 33 1/3 years, the trust fund attracts tax at the 20% lifetime rate. This means a maximum tax charge every ten years of 6% and very often less than that, given availability of the nil-rate band and any reliefs; and

(ii)  an exit charge, which varies according to whether it occurs in the first ten years or thereafter (IHTA 1984 s65 and see 3.7.4).  In the first ten years the notional value charged is equal to that of the assets advanced, by reference to a given fraction of the rate at which tax would be payable at the exit date on the funds settled given the initial cumulative total. This means that if the initial funds settled plus any additions to the settlement fall within the nil-rate band in force at exit within the first ten years, there is no exit charge whatever the then value.

TAX TRAP: the rate of tax on exit within the first ten years is found by reference to the value of the assets when settled before BPR or APR (IHTA 1984 s68(5)(a)). It is not enough therefore for the initial value to be within the nil-rate band solely because of APR/BPR, as this could give rise to a positive rate of tax. However, this will matter only if the property concerned does not itself attract APR or BPR. The exit charge after the first ten year anniversary is an appropriate fraction of the rate charged at the previous anniversary.

(b) Accumulation and Maintenance trusts (A&M trusts) made before 22 March 2006 
This are a special category of settlement (defined in IHTA 1984 s71), made broadly for children or grandchildren of the settlor, which received special treatment as discretionary settlements from 1975 to 2006 through an exemption from the ten year anniversary and exit charges (see 3.4).  However, no new such settlements can be made on or after 22 March 2006 and a transitional regime which ended on 5 April 2008 applied to such A&M trusts in being at that date (see 3.5).

(c)The ‘section 49 regime’
This embraces settlements which are treated as if the underlying trust property were owned beneficially by the beneficiary (IHTA 1984 s49(1)), namely interest in possession settlements made before 22 March 2006 so long as the interest in existence at that date continues or is replaced by a qualifying ‘transitional serial interest’ (see 3.6).  This point also applies to life interests under Wills whenever the death occurs (called ‘immediate post-death interests’ or IPDIs): see 18.3.  That means that, for example, on death of the beneficiary the trust property to which he has had a right to income is added to his free estate, and a single ‘estate rate’ is calculated, to be applied separately to the free estate and the settled estate (subject of course always to exemptions such as the spouse/civil partner exemption). 

(d) The ‘age 18-to-25’ trust
This type of trust, whether arising out of an A&M trust for the settlor’s children or grandchildren or created under a Will for the testator’s children (IHTA 1984 s71D), suffers an exit charge at a maximum of 4.2%, rather as under the A&M regime (see 18.5.4).