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Putting estate into gear

I am a widow aged 59 with two children who are now in their 30s. I have a variety of assets, including a large amount of cash on deposit. I have some income from pensions but also rely on the interest from my deposits to supplement this. I have heard there are some trust arrangements I could consider to help mitigate the inheritance tax liability on my death. Please can you explain my options?

The type of trust arrangements to consider depend on your income and/or capital requirements in the short, medium and long term.

When monies are placed into a trust arrangement, in broad terms you are effectively giving up access to the capital. Also, any assets you gift into trust or to an individual will only fall totally outside your estate once you have survived seven years after making the gift.

There are many types of trust but I will briefly describe two ways in which you could consider using trusts to mitigate your liability.

Loan trust

This works by an individual, known as the settlor, setting up a trust and appointing trustees and beneficiaries. You make an interest-free loan to the trustees of the trust, which is repayable on demand by yourself. This money is then placed into a single-premium insurance bond, which is invested in funds offering a wide choice of investments, for example, cash, property, fixed interest, stocks and shares.

During your lifetime, you retain full access to the capital you have invested into the trust and this is repaid by way of interest-free loan repayments. In the event of your death, all investment growth is totally outside your estate.

With regard to the initial capital you invested, as this is effectively a loan, in the event of your death the amount of monies that have not been repaid to you will fall back into your estate and be subject to inheritance tax.

Turning to the single-premium insurance bond that is held within the trust, you are able to take up to 5 per cent of the amount invested without any immediate tax liability. Any unused 5 per cent allowance can be carried forward to future years. Thus, if no withdrawals are taken for, say, three years, a total of 15 per cent of the invested monies could be withdrawn without any immediate tax liability.

As well as helping to reduce your inheritance tax liability, this will also have a more immediate benefit of reducing your income tax liability while still maintaining your income requirements.

It is important to point out that once the initial investment has been repaid to you, you have no access or rights to any surplus monies within the bond as these will then pass to your beneficiaries on your eventual demise.

Discounted gift trust

This type of trust is appropriate for individuals who wish to reduce their inheritance tax liability by giving away capital but who still require income from their investments.

You set up the trust by gifting cash to the trustees. You will automatically be included as a trustee of the trust. The monies are invested into a single-premium investment bond as with the loan trust.

On setting up the trust, you then specify from outset the details of the income you wish to receive from it in order to meet your normal living expenditure. These amounts are fixed at outset and are payable as long as you live.

In the normal course of events, any gift of assets into a trust becomes what is known as a potentially-exempt transfer. For the total amount to be outside your estate, you need to survive seven years from making the gift. Up to seven years, any inheritance tax due on the gift reduces on a sliding scale.

One of the main benefits of this trust is the ability to obtain an immediate discount for inheritance tax purposes on the lump sum invested in the event of death within the standard seven-year rule for potentially-exempt transfers. The discount given is the amount immediately removed from your estate in respect of an inheritance tax calculation, based on your age, health and the fixed income level you choose to withdraw. There is no guarantee that this will be accepted by the Capital Taxes Office, which is why medical underwriting at the time of implementation is generally recommended.

In addition to this discount, all growth achieved within the trust falls outside your estate from day one.

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