Funding a UK discretionary trust with gifts from surplus income

As excess income is paid into such a trust and accumulates over time, this exemption can prove itself to be extremely beneficial.

There is the possibility that this very specific exemption could be removed if any inheritance tax changes take place as future governments consider reforms. Now is therefore an opportune time for those who find themselves with excess income to give further consideration to securing this valuable exemption.

What are the benefits of gifting surplus income into a discretionary trust?

For gifts which meet the qualifying conditions, there is no limit to the amount of excess income that can be gifted, and no requirement to survive seven years with the funds being immediately outside of the estate for inheritance tax purposes.

Where surplus income amounts are large – or beneficiaries are young or vulnerable – gifting income outright may not be appropriate.

This is where a discretionary trust works perfectly; it ensures the inheritance tax exemption is used whilst available but allows the funds to accumulate, thus protecting family wealth and passing funds to the next generation in a controlled manner. For example, payments can be made for university costs or a house purchase at a more appropriate time in the future.

What are the conditions for claiming the inheritance tax exemption?

In order to claim the inheritance tax exemption (IHTA 1984, S 21), gifts must be from current income, which includes earned income, dividends, rental income or pension income – but not capital. Accumulated income from previous years may be deemed as capital and therefore be ineligible.

Although gifts do not have to be for the same amount or over a set period of time, the gifts should be regular or usual in nature and maintain a consistent pattern.

You will need to demonstrate that you, as the donor of such gifts, will not suffer any negative impact on your own standard of living by making the gift.

It is important that clear records are kept evidencing the gifts and the intention to make regular payments. These will be used by the personal representatives administering the donor’s estate in due course as evidence to claim the exemption.

Provided you are able to meet the qualifying conditions, you may decide that creating a UK discretionary trust from gifting surplus income is an appropriate choice for your circumstances. However, as with all significant wealth structuring decisions, it is important to seek advice at the outset and gain an understanding of all the options available to you.

How ZEDRA can help

ZEDRA can support you with the creation and ongoing administration of discretionary trusts and ensure that record keeping is clear and consistent, supporting the ability to claim the inheritance tax exemption in due time.

Contact Laura Tommis to discuss the options available to you.