Following the UK government’s Autumn Budget, more families are likely to be worried about exposure to inheritance tax and with it being the season of goodwill, some may be considering larger gifts than usual to family members, says RSM’s Chris Etherington.
Many will be aware of the general rule that someone’s exposure to inheritance tax (IHT) can be reduced if gifts are made during their lifetime. Typically, such gifts will be fully exempt if the gift is survived by seven years and the potential IHT on the gift starts to reduce once three years have passed.
On the surface, it can appear a straightforward decision but for many parents, deciding how much to give away and when can be a challenging one that many wrestle with. Some parents can be worried about giving away too much, too soon to their children and potentially diluting some of their drive and ambition. Others may harbour concerns about future relationships their children may have and the impact a break-up might have on any assets or funds gifted. In other cases, it may simply be considered that the child is too young to receive a gift directly.
An answer to such concerns can be to look at making a gift to a family trust instead. The family trust is arguably an ironic title as it can allow someone to make gifts indirectly to a family member who they do not necessarily trust to receive the gift themselves yet. The person making the gift, known as a settlor, can retain control of the asset or funds gifted to the trust during their lifetime but will usually be prevented from benefiting from it.
Despite having a clear role to play in passing assets from one generation of a family to another, the number of trusts submitting tax returns has substantially declined over the last 20 years or so. The latest statistics from HMRC indicate that from 2004 to 2023 the number of trusts in self-assessment fell from 225,000 to 147,000. This is in part due to significant changes to the taxation of trusts that were introduced by Gordon Brown as chancellor in 2006.
However, one of the unintended consequences of Rachel Reeves’ first budget is that there may be a resurgence in the establishment of new family trusts. The proposed changes to agricultural relief and business relief mean that an individual will only receive 100% IHT relief on the first £1m of qualifying assets held at death. An individual could however effectively double this allowance if they establish a family trust as that can also benefit from its own £1m allowance. However, where trusts are created by the same settlor on or after 30 October 2024, this £1m allowance will be divided between those trusts.
As a result, each individual in the family business may think about establishing a trust, with a view to protecting as much of the value from IHT as possible. Similarly, those with pension pots that will be brought into the IHT net may start thinking about giving away other assets using a trust, or even funding the trust with surplus income paid from the pension.
Establishing a family trust is clearly not something that should be rushed into. There are complicated tax rules to consider and those taking on the role of a trustee need to understand what their responsibilities are. What this does highlight is that, rather than generating significant additional revenues for the Treasury, the proposed budget IHT relief changes could simply distort taxpayer behaviour. For those individuals and businesses impacted, important decisions around gifts and business ownership could end up being made for the wrong reasons.
