As of 2023, the tax situation for discretionary trusts in the UK includes a few key elements:
- Initial Set Up: When establishing a discretionary trust, you must pay a 20% IHT on the value of the assets that exceed your personal allowance. The current personal allowance is £325,000. For instance, if you place assets worth £400,000 into the trust and you haven’t used any of your allowance elsewhere, you would pay £15,000. This amount is 20% of the £75,000 that is in excess of the £325,000 allowance1.
- Every 10-Year Anniversary: Assets in the trust must be revalued every decade. After this revaluation, a 6% tax is levied on the value of the total assets, less the £325,000 IHT allowance2. For example, if your initial £400,000 investment increased in value to £500,000 over the decade, IHT would be due on £175,000. This amount is the value exceeding the £325,000 allowance, which would result in a tax bill of £10,500 (6% of £175,000)3.
- Exit Tax: Finally, when the trust is closed or assets are removed from it, IHT needs to be paid again. This tax is based on the most recent 10-year anniversary valuation, and it can be up to 6%, charged on a pro-rata basis. For instance, if the trust is closed five years after a 10-year anniversary, the tax rate would be halved to 3%45.
These tax liabilities demonstrate that while discretionary trusts can be a useful tool for managing and potentially mitigating inheritance tax, they also carry significant tax implications that need to be carefully considered and planned for.
In addition to IHT, discretionary trusts are subject to other types of taxes in the UK:
- Income Tax: Any income earned by the trust above £1,000 per annum is taxed at a rate of 45%6.
- Capital Gains Tax: There is an allowance of £6,000, which is divided by the number of trusts settled subject to a minimum of £1,200 per trust. The capital gains tax rate is 20%, but it increases to 28% for residential property7.
- Dividend Tax: Dividends up to £1,000 per annum are taxed at 7.5%, while dividends above £1,000 per annum are taxed at a rate of 38.1%8.
It’s important to remember that tax laws and regulations can change over time, and the specific details of your situation can greatly impact the effectiveness of a discretionary trust for IHT planning. Therefore, it is always advisable to seek professional advice when considering such strategies. Financial advisors and tax professionals can provide guidance tailored to your individual circumstances and help you navigate the complexities of IHT planning.