Briefly, since 2006, most new trusts are taxed to IHT at various stages of their existence. Transfers into trust can be taxed at the "lifetime rate" of 20%, depending on the value of the assets transferred and the value of other trusts settled by the same person in the previous seven years. (It can be helpful here to think of IHT as a tax on gifting rather than a tax on death.)
During the existence of a trust, IHT is paid on the value of the assets in the trust every ten years and also when assets are transferred out of the trust, where the value of the assets exceed the nil rate band (currently £325,000). Those charges will vary and are notoriously cumbersome to calculate but can be anything up to 6%. Further IHT may also be due if the person who transferred the assets into the trust dies within seven years of doing so.
Gifts to individuals don't carry those complications, and as long as the person gifting the assets survives for seven years, those assets would fall out of their estate. So why would anyone transfer assets to a trust? There are many valid reasons to do so, including protecting assets for vulnerable individuals, such as children, or allowing flexibility to provide for different family members as time moves on.
The Government has been concerned by the way that some people use multiple trusts to try to avoid these ongoing charges. It is a relatively common tax-planning tool for people to make Wills in which they leave legacies to multiple trusts, all of which were set up on different days. The theory behind this was that each of the legacies would be for a sum below the nil rate band, meaning that each trust would avoid the ongoing IHT charges that apply to trusts for so long as they remained below the nil rate band. The trusts have to be set up on different days to avoid being identified as "related settlements" with the result that all of the funds in the various trusts would be assessed together at each of the IHT charge dates.
These types of trusts are known as "pilot trusts", as they sit flickering in the background - like a pilot light on a boiler - ready to kick into action at a later date when they receive substantial funds.
One proposal put forward to change the system was to give every person a single nil rate band for IHT to split between any trusts that they settled during their lifetime. That would have included all sorts of different trusts, including those set up to receive life policy proceeds. Crucially, that also would have meant that individuals would not receive a "refresh" of their nil rate band every seven years, as they do currently.
Thankfully this proposal has been shelved by the Government, as confirmed in the Chancellor's Autumn Statement in December last year. Instead, the Government plans to target specifically the use of multiple trusts to gain an ongoing IHT advantage and we now have the detail of those proposals in the form of the draft Finance Bill 2015.
The key new rules state that all transfers into two or more trusts on the same day must be taken into account when assessing each trust's ongoing IHT charges, like the "related settlement" rules described above. Assets passing on your death do so on the same day (i.e. the date that you die). This means that, if your Will contains various legacies to multiple pilot trusts, all of those legacies might be taken into account when it comes to calculating the IHT charges every ten years and on any exits from each trust, with the result that IHT will be due where it might not have been previously. There are exceptions to the new rule, such as liferent trusts set up under your Will, but that is the basic premise. The Bill is presently making its way through Parliament.
Most other estate planning using pilot trusts should not be affected, so long as you are not using more than one trust to receive your pension death benefits or life policy proceeds, but it is worth having a full review of your estate planning to check. If you would like any advice or assistance about these issues, please get in touch with our Asset Protection team.