Gordon Brown claims his changes to trust law will rake
in just £15 million in tax this year but they are
causing havoc to the wills of up to 1m people. Who is
likely to be affected.
Up to one million people will be forced to rewrite their
wills following radical changes to the taxing of trusts
confirmed 10 days ago in the Finance Bill.
The controversial new rules first emerged in the small
print of Gordon Brown's 10th Budget last month. The chancellor
said raking in more tax was not his aim and claimed only
£15 million would be generated in the first year
with just 20,000 trusts affected.
But this 20,000 figure has been hotly disputed by enraged
lawyers and accountants, who say that hundreds of thousands
more people will be affected by the time they die.
The Association of Chartered Certified Accountants estimates
that 1m people will need to check their estate planning
arrangements, at an estimated cost of £250m, a disproportionately
large sum for the small amount of revenue expected to
be generated in the first year.
The changes will affect those who die leaving assets
of more than the IHT threshold (£285,000 in this
tax year) via trusts that aim to protect their wealth
for their children. The Treasury says the great mass of
people will not be affected by the changes because they
do not pay IHT - currently only 6 per cent of those dying
pay the tax and many of them do not set up trusts through
their wills.
But with property prices outpacing inflation-based increases
in the IHT threshold, growing numbers of estates will
be hit by death duties.
Halifax predicts that more than four million estates
will be subject to IHT by 2020; many of those affected
will want to protect their estate for their children through
trusts.
If you have set up a trust, or have planned in your will
for one to be set up when you die, the chances are that
you need to look at your arrangements again.
The changes
The new rules introduce a new inheritance tax
liability that affects trusts set up both when you are
alive and on your death through your will. The main tax
structures to be affected are accumulation and maintenance
trusts, interest in possession trusts and some life insurance
policies that are written in trust.
Accumulation and maintenance trusts are commonly set
up by grandparents to provide for children's education.
They are also common in wills, providing for the payment
of school and university fees of orphaned children but
preventing them from getting their hands on the rest of
the cash until they are 25.
Until this year's Budget, these trusts did not attract
IHT. But now parents and grandparents face the choice
of either giving the child access to the entire inheritance
at age 18 and maintaining the trust's tax-free status
or leaving the age 25 condition and paying six per cent
tax every 10 years on everything over the nil-rate band
plus a tax charge of up to six per cent tax when the fund
pays out. New trusts would also pay 20 per cent IHT on
money over the nil-rate band going into the trust.
Many people may think that paying this extra tax would
be better than having the money given to their children
while they are still immature.
"This change places parents in a terrible dilemma
because it is now more tax-efficient to give a large amount
of wealth to their offspring at age 18 when many will
not be mature enough to handle it," says Mike Warburton,
a senior tax partner at Grant Thornton, the accountants.
"I have seen cases where clients' children have gone
off the rails when coming into money too young, killing
themselves in sports cars, getting into drugs or becoming
involved with unsuitable marriages."
If you want to change an existing accumulation and maintenance
trust so that the child gets the estate at age 18 in order
to avoid having to pay tax on it, you have until April
6 2008 to do so. By doing this you will not be treated
as having set up a new trust for inheritance tax purposes.
This is important because the new rules have stopped allowing
gifts into trusts tax-free, which means that you are now
allowed to make gifts into trust only up to the nil-rate
threshold. By taking advantage of this transitional protection,
changing the trust you have already set up will not count
as a new gift in relation to your inheritance tax gift
limit, which is not the case if you change it after the
two-year transition period.
The amount you can pay into trusts tax-free is now limited
to £285,000 in any seven-year period. Anything paid
into trusts over that figure attracts a 20 per cent tax
on the way into the trust, as well as up to 6 per cent
tax every 10 years and 6 per cent when the trust finally
pays out.
Interest in possession trusts, which are commonly set
up to give a spouse or widow an income for life with the
capital passing to the children on death, will also become
less flexible.
Payments into trusts that benefit spouses are still exempt
from IHT but will now be less useful as a tax-planning
vehicle because of new restrictions on how the funds in
the trust can be paid out. "The new rules make it
more difficult to use the spouse as a conduit for passing
assets to your children while avoiding IHT," says
David Kilshaw, a tax planner at KPMG, the accountants.
"So if you have set up an interest in possession
trust you will need to go through it with your lawyer."
What is not affected
Discretionary will trusts that pass wealth between
spouses up to the nil-rate threshold are unaffected by
the rule changes. These are trusts set up by married couples
and civil partners to utilise two sets of nil-rate band
instead of one. Bequests on death pass between married
couples and people in registered same-sex partnerships
without incurring inheritance tax, allowing the first
member of the couple to die to pass their estate to their
partner without using up their £275,000 IHT allowance.
Both £275,000 allowances can then be used on the
second death, giving a total IHT exemption for estates
up to £550,000.
If you are one of the 200,000 people a year who buy a
£14.99 Lawpack do-it-yourself will preparation pack
through Tesco, you will not be affected by the changes
because these wills do not contain trust clauses.
Initial fears that 4.5 million life insurance policies
would be hit by the changes were dispelled when the Treasury
rushed out a statement 10 days ago declaring them exempt.
Now most straightforward term life assurance will be untouched
by the changes. The reason for this is that a life policy
is treated as having very little monetary worth as long
as the policyholder is healthy, because there is little
chance of it having to pay out.
However, if you have a life-threatening illness the policy
would be deemed to be valuable and you could face a 6
per cent tax charge on each 10th anniversary of the policy
being taken out. This seemingly contradictory state of
affairs is one area where life insurers are lobbying hard
for changes.
Some investment bonds are set up on a trust basis and
they could be hit by new tax liabilities, depending on
their specific wording. In some circumstances it could
be worth restructuring them during the two-year transition
window, so get professional advice before doing anything.
"The Treasury has stated categorically that there
are no retrospective taxes in this Budget," says
Julie Hutchison, an estate planning specialist at Standard
Life.
"But we have identified clear examples of retrospective
taxation. It is essential to speak to your IFA if you
set up a life office trust before this year's Budget."
What should you do now?
Lawyers, accountants and financial services companies
are lobbying hard for the most unpopular parts of this
new legislation to be dropped.
As the Government has already granted a two-year window
for protecting certain tax advantages in trusts, experts
recommend that anyone in a good state of health should
wait until June to see if any more changes are brought
in when the Finance Bill is made law.
But anyone who thinks they may be near death should contact
their lawyer, accountant or financial adviser to get professional
advice on their trusts and estate planning arrangements.
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