Lifetime Planning: Inheritance Tax Planning using Gift Trusts and Holdover Gift Trusts

Where death planning doesn’t achieve all of a client’s aims or solve all their Inheritance Tax issues, our Gift Trusts and Holdover Gift Trusts provide the answer the client is looking for! With clients whose overall estate value is above their available allowances, the only way to reduce the IHT their executors will have to pay on their death is to reduce their estate value by gifting. This also means clients make use of lifetime reliefs or exemptions under the saying ‘use it or lose it’.

PETs vs CLTs

It’s essential you understand the differences between a ‘Potentially Exempt Transfer’ (‘PET’) and a ‘Chargeable Lifetime Transfer’ (‘CLT’) before you get started. A PET is usually a gift from one individual to another; for example, parents gifting cash to a child or an aunt gifting a second property to a nephew. PETs are regarded as exempt from Inheritance Tax when they are made, therefore there is no limit on the value of a PET, but they will become chargeable to Inheritance Tax if the donor dies within 7 years of the gift being made, making them ‘potentially exempt’ until 7 years have passed!

A CLT on the other hand is a transfer to Trust that is immediately chargeable. For a CLT, the available Nil Rate Band (NRB) is used first and this is charged at 0% for Inheritance Tax; anything above the available NRB is charged at a 20% entry charge rate for Inheritance Tax (half the death rate for inheritance tax of 40%). If a client passes away within 7 years of gifting a CLT that was above the available NRB, the portion above the available allowances will then be charged the extra 20% inheritance tax (to equal 40% inheritance tax paid in total). The available NRB replenishes every 7 years so with CLT’s, clients can look at completing a further CLT after 7 years have passed since the first one, in order to avoid paying any entry charges (as long as all of the CLT’s are below the available NRB at the time).

Let’s set out an example of this: A client transferred a property worth £500k into a Gift Trust during their lifetime (assuming they have a full NRB available), the first £325,000 would be charged at 0% inheritance tax, assuming the client had already used their £3,000 annual gifting allowance.

The remaining £175,000 would be charged a 20% entry charge for inheritance tax, meaning that on transfer in, £35,000 Inheritance Tax would be payable by the settlor.

If the client passed away 1 year after completing the CLT, the portion above the available allowances (£175,000) would then be charged a further 20% Inheritance Tax (a further £35,000) to equal a total of 40% Inheritance Tax paid on the amount above the available NRB. An important point to note is that any growth on the gifted assets would not form part of the client’s estate as the value of the gift is fixed at the point the gift is made.

If clients are looking to gift via a PET and via a CLT, it is also really important to consider what estate planners like to call the ‘14 year shadow’ as well as the order of gifting. Please review the course recording for more information.

As you can see from the above example, transfers to Gift Trusts and Holdover Gift Trusts are CLTs, therefore our recommendations are that clients only transfer assets in that are under their available NRB, in order to avoid an entry charge. If a client transfers an asset into a Gift Trust or a Holdover Gift Trust and survives for 7 years, the value of the asset will then be outside of their estate for Inheritance Tax purposes… sounds ideal… but what are the other considerations with this planning?

So, why use trusts?

Clients may question why they should use a Trust for the gift and not just gift absolutely. There are many downsides to gifting absolutely which many of our advisers will already be aware of, the main ones being:

• Inheritance Tax (absolute gifts automatically form part of the done’s estate for IHT purposes whilst also remaining in the donor’s estate for IHT purposes for 7 years, which results in poor planning for both parties!)
• Control (with absolute gifting the donor doesn’t retain any control over the asset) and the fact that holdover relief can’t be claimed on absolute gifts (we will be coming back to holdover relief shortly).

Capital Gains Tax (‘CGT’) is often something clients don’t consider when disposing of assets such as additional properties or shares for Inheritance Tax planning purposes. CGT is charged on the chargeable gains on the disposal of assets – and transfer of an asset to Trust is classed as a disposal of an asset (as is a sale or other transfer).

It is important to bear in mind that a sale or a gift is treated as a disposal at market value even if no consideration is paid, so clients can’t get around paying CGT by gifting assets for no consideration or selling them at an undervalue.

There are some exemptions and reliefs for CGT which are covered in detail in the course. The difficulty that a lot of clients often end up with is that they may be asset rich but cash poor. So, they have assets they can consider gifting to Trust during their lifetime as part of their Inheritance Tax planning, but don’t have the spare funds to pay the CGT upfront on the transfer.

Let’s look at an example of this: A client purchased a second property in 2000 for £125,000 and has rented this property out since then (never lived there as their own main residence). In 2020 they decided to transfer the whole property to a Gift Trust; at this point the property was valued at £350,000, therefore on the transfer to Trust, CGT will be payable as there are no reliefs applicable.

The basic calculation for CGT is the total chargeable gain (£350,000 – £125,000 = £225,000) minus the annual exemption (£3,000 for individuals in 2025/26), which leaves us with £222,000, this is then charged at the client’s rate of CGT which is dependent on which income tax bracket they are in.

If this client is a higher rate taxpayer the CGT will be charged at 24%, resulting in £53,280 CGT payable (£222,000 x 24%). If the client is a basic rate taxpayer, the CGT will be charged at 18% up to the point at which, when the gain is added to their income, they become a higher rate income taxpayer with the balance at 24%.

Hold it over!

In short, if gifting to a certain type of trust – such as the Family Holdover Gift Trust – then holdover relief can be claimed. Holdover relief defers CGT until a later disposal, so the CGT applicable on the transfer to Trust isn’t eliminated, it is just deferred until the Trust disposes of the asset in the future.