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Absolute or discretionary trust and IHT

The following article provides information about inheritance tax planning for UK domiciled individuals where a gift has been made and the individual does not require access to capital or withdrawals.

Case study

Mark Thompson (aged 50) moved to Hong Kong from the UK 2 years ago to take up a job there. He has been married to Lucy for 10 years and has two children Joseph aged
10 and Theo aged 8. They plan to return to the UK in the future. His salary is
HK$1,125,000. His estate is currently worth HK$7,950,000.

As Mark is still UK domiciled, he wants to minimise the UK inheritance tax (IHT) payable. Having made no previous gifts, he is happy to invest HK$2,000,000 into an offshore bond which he requires no access to, for the eventual benefit of his children.

If Mark wants to be certain that Joseph and Theo will benefit from the trust property then an absolute trust can be used. However, if Mark wants the flexibility to be able add another child to the trust if his circumstances change, then a discretionary trust can be used.

Mark has made no previous gifts, and this gift is within the UK nil­rate band (NRB) (which for 2016/2017 is £325,000), no IHT would be payable at the time the gift is made for both trusts.

After 7 years the gift will fall outside Mark’s estate for IHT purposes for both trusts. Growth on the investment is outside the estate immediately for both trusts. So for example, if the trust fund grows to HK$2,500,000 then HK$500,000 is immediately outside Mark’s estate.

Mark is also able to appoint himself and Lucy as trustees to retain control.

How an offshore bond subject to an absolute trust may help

  • Define who they want to benefit by naming them.
  • No tax is payable at the time the Potentially Exempt Transfer (PET) is made.
  • After 7 years the PET will fall outside estate for IHT purposes.
  • Growth on the investment is immediately outside the estate.
  • No liability to periodic and exit charges in future years because the trust is not subject to the discretionary trust tax regime.
  • Probate can be avoided on death if the policy is subject to a trust and provided there is at least one remaining trustee.
  • Upon return to the UK, chargeable events are assessable on the UK resident beneficiary unless income arises from a parental gift and is more than £100. In which case, it is assessable on the parent. 

How a offshore bond subject to a discretionary trust may help

  • Wide class of beneficiaries, therefore flexible in that additional children will automatically be included within the “children” class of beneficiaries. A ‘letter of wishes’ can be used to inform the trustees who Mark would like to benefit from the trust and when.
  • No IHT is payable at the time the Chargeable Lifetime Transfer (CLT) is made if it and other CLT’s made in the previous 7 years are within the NRB.
  • After 7 years the CLT will fall outside estate for IHT purposes.
  • Growth on the investment is immediately outside the estate.
  • No liability to IHT if one of the beneficiaries dies.
  • Probate can be avoided on death if the policy is subject to a trust and provided there is at least one remaining trustee.
  • Upon return to the UK, chargeable events are assessable on the settlor provided he is alive and resident in the UK; or where the chargeable event occurs in the tax year of the settlor's death. 

Additional points to consider – absolute trust

  • Trustees cannot change the named beneficiaries.
  • Beneficiaries will have an entitlement to their share of the trust fund when they reach age 18 regardless of their circumstances at the time.
  • When an absolute beneficiary dies, their share of the trust fund will form part of their estate for IHT purposes. 

Additional points to consider – discretionary trust

  • Trustees will use their discretion to decide who should benefit from the trust fund, whilst Mark can make his wishes known to the trustees, they will ultimately decide.
  • The trust fund may be subject to periodic and exit charges in future years.
  • Upon return to the UK, if not assessed on the settlor, the chargeable event gains would be assessable on UK resident trustees then any UK beneficiary receiving a benefit under the trust.

 

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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