For inheritance tax (IHT) purposes, there are a number of different types of trust that can be created. Each of these have different tax regimes that apply to those trusts. It is important to understand what trusts the testator’s will is creating for them, the tax effects of that trust and any other consequences that the trust could have for the trust assets or beneficiary.
Interest in Possession Trust
An interest in possession trust is a trust in which the life tenant of the trust is treated as owning the trust assets for inheritance tax purposes. When the life tenant dies, the trust assets will be revalued and taxed as part of their estate.
An interest in possession trust must either be a qualifying disabled persons trust or alternatively an immediate post-death interest. Most life interest trusts, such as a life interest over the residuary estate or a protective property trust or right to occupy, should be treated as an interest in possession trust.
Bereaved Minor’s Trust
A bereaved minor’s trust is a trust set up on a testator’s death for one of their children to hold assets until that child has reached the age of 18.
While the minor is under 18 the trustees may accumulate any income produced, or apply income or capital for the minor’s education, maintenance or other benefit as they see fit. They can do this either by using it directly for the minor’s benefit themselves, or by paying it to the minor’s surviving parent or guardian. When the minor turns 18 they will become absolutely entitled to the trust fund and will inherit it absolutely.
There are no ongoing anniversary charges or exit charges for a bereaved minor’s trust and there will also be no IHT charge when the minor becomes absolutely entitled to capital or dies before becoming entitled to it.
Bereaved Young Person’s Trust
A bereaved young person’s trust (also known as an 18-25 trust) is a trust set up on a testator’s death to hold assets for one of the testator’s children until that child has reached an age over 18 but no higher than 25.
The trustees can either accumulate the income generated by the trust or apply the income and capital of the trust for the beneficiary’s education, maintenance or other benefit as they see fit. Whilst the beneficiary is under 18, the trustees can apply income and capital either by using it directly for the beneficiary’s benefit themselves, or by paying it to the beneficiary’s surviving parent or guardian. When the beneficiary has reached 18, they can either apply the income and capital directly for the beneficiary’s benefit or apply it to the beneficiary outright.
When the beneficiary reaches their attainment age, which can be no later than 25, they will become absolutely entitled to the trust fund and will inherit it absolutely.
Bereaved young person’s trusts have their own separate IHT rules.
There will be no IHT charge if:
- the beneficiary becomes entitled to capital at or under 18;
- the beneficiary dies under 18;
- the trust becomes a trust for bereaved minors while the beneficiary is under 18;
- the trustees make an advance of assets for the benefit of the beneficiary at or under 18; or
- the trustees make an advance of assets within the first quarter following the beneficiary reaching 18 or the trust beginning.
There is an exit charge when assets leave a Bereaved Young Persons Trust in all other cases. The exit charge that applies when a beneficiary is between 18 and 25 is calculated depending on how many full quarters have elapsed since the beneficiary reached 18 or when the trust was set up if later. The maximum rate of charge is 4.2% for assets above the NRB, compared to the rate for a relevant property trust which is 6%.
There are no anniversary charges for a bereaved young person’s trust.
A bare trust is a trust where the beneficiaries of that trust have an immediate and absolute right to both the income and capital of that trust.
Bare trusts are most commonly creating by leaving a gift to a minor with no age condition. In which case, the trustees have the duty to invest the assets and consider how the trust income and capital should be used for the minor’s benefit. Once the minor has reached 18, they can then demand that the trustees release the assets to them.
If a bare trust is created for an adult beneficiary, the trustees have no active duties to perform apart from following the instructions of the beneficiary.
For IHT purposes the beneficiary is treated as inheriting the trust assets and owning them. There are no anniversary or exit charges and no charge when the trustees advance the trust assets to the beneficiary and end the trust. As the beneficiary is treated as owning the trust assets, if they die the assets are treated as theirs and both pass by the beneficiary’s will or intestacy and are taxed as part of their estate.
Relevant Property Trust
Any trust that does not qualify as any of the above trusts is treated as a relevant property trust for inheritance tax purposes. Discretionary trusts and age condition trusts for grandchildren are common examples of relevant property trusts.
Relevant property trusts have their own specific IHT regime. Apart from being taxed when the trust is created as part of the testator’s estate, there are two separate times when a relevant property trust will be taxed for IHT.
Firstly, an exit charge will apply to the trust when capital is distributed to the beneficiaries. Secondly, an anniversary charge will apply every 10 years from the date the trust was created. There will be no anniversary or exit charges if the trust is under the value of the NRB.
The exact calculation for calculating anniversary and exit charges are complicated and will vary depending on a number of circumstances. The combined value of exit charges and anniversary charges every 10 years will not exceed the value of 6% of what is over the NRB.
There are no exit charges on distributions within the first two years of the testator’s death. These distributions are instead treated for IHT purposes as if the testator had made these by their will under S144 Inheritance Tax Act 1984.