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How Inheritance Trusts
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Inheritance Trusts can either be established in the form of an Absolute Trust (also known as a ‘Bare’ trust) or as a Discretionary Trust. Great care must be taken in deciding which type to use and (if both are required) the order in which they are created may be important. Together with your tax or legal adviser we will guide you on this.

Under an Absolute or Bare Trust, the initial capital amount gifted is normally a Potentially Exempt Transfer and the full amount will fall outside your estate for tax purposes if you survive for 7 years. If you die before then the value of the gift is counted as part of your estate, but reduced on a sliding scale from years 3 to 7.

However under this type of trust the beneficiaries cannot be changed nor the proportions to which they will benefit from the trust fund. In certain circumstances this could become a problem. Care also needs to be taken about the implications for potential tax arising on the estates of beneficiaries if they were to predecease you. In certain circumstances this could be calamitous!

The advantage of a Discretionary Trust is that you can add or remove beneficiaries or change the split of benefits between them as and when it is appropriate. Furthermore, it avoids potential tax problems for beneficiaries who die prematurely.

However, under a Discretionary Trust the initial transfer is not classed as a Potentially Exempt Transfer and is therefore immediately chargeable to Inheritance Tax. That could mean an initial tax charge at half of the full IHT rate*, and subsequent periodic tax charges every 10 years thereafter. Further tax may also on capital distributions out of the trust when these occur.

However, an initial tax charge would only arise in practice if the transfers to a Discretionary Trust take you over your nil rate threshold for Inheritance after taking into account any chargeable transfers in the previous seven years. Periodic charges will give rise to tax only if the value at the relevant anniversary dates takes you over the threshold at that time. This is also the case if an exit charge arises in the first 10 years. Exit charges after 10 years are based on the level of periodic charge (if any) at the last period end.