Inheritance Tax Review & Trust Wind-Up Case Study

Inheritance tax is a significant charge levied on an individual's estate on death at a rate of 40%. Several planning opportunities are available to mitigate IHT exposure and allow maximum value to be transferred to children and beneficiaries. However, these mitigation strategies must be reviewed periodically to ensure they remain fit for purpose and continue to achieve the client's objectives.

This case study examines a recent engagement where we helped a client review her inheritance tax position and consider winding up her discretionary trusts established in the 1990s that were no longer serving their intended purpose. The case highlights the importance of regular reviews and the tax planning opportunities and implications that can arise when trusts are wound up.

The Client

We were approached by a client in her late 60s, with a substantial estate valued at £3 million. This included her main residence, investment properties, various investments (ISAs, pensions and several life insurance policies. In addition, two discretionary trusts established in the 90s held a further £580,000 in investments and cash.

The trusts had been set up to mitigate inheritance tax and provide control and flexibility for the family, while allowing the children to benefit from the income of the investments and cash at the time. However, the client had not reviewed these arrangements for many years and was unsure whether they remained appropriate given the changes to trust taxation over the years and whether the trusts still served the primary objective, given the children’s ages now.

With her children now adults and financially independent, the client questioned whether the ongoing costs and complexity of maintaining the trusts were still justified. She wanted to simplify her affairs and allow her children to manage the assets directly, as she was keen to allow her adult children to now benefit and manage these assets directly, rather than waiting until her death.

She wanted also wanted to review her overall IHT position and assess the potential IHT liability on death.

The Problem

With her estate valued at approximately £3 million, with a further £580,000 held across the two trusts, there was a significant IHT liability on death. Her concerns included:

• Outdated structures – were they still tax-efficient?

• Upcoming tax charges – One trust was approaching its 10-year anniversary, which would trigger an IHT periodic charge.

• Ongoing costs – Annual tax returns, trustee meetings, and professional fees of around £3,000 per year – was this still justified?

• Overall exposure – She had not reviewed her IHT position for over a decade and wanted clarity on her potential liability.

Our Approach

We carried out a comprehensive review of the client's estate and trust arrangements, including valuing all assets, reviewing the trust deeds, exploring various mitigation strategies to mitigate her IHT position and modelling the tax implications of different options.

We also reviewed the client’s life insurance policies to understand how each was held.

We delivered a report explaining the current position of her estate and IHT position. The main concern was around the existing trusts.

Our analysis confirmed that the trusts, while appropriate when established, were no longer providing significant tax benefits. The ongoing periodic charges, admin costs and complexity of maintenance outweighed the advantages of retaining them. The client was keen on simplifying her tax affairs and admin.

We explained that winding up a discretionary trust and distributing assets to beneficiaries have several tax consequences that must be carefully managed: as two main tax consequences:

IHT exit charges

When transferring assets outside the settlement, an IHT charge would apply based on the number of complete quarters since the last 10-year anniversary and the value of the assets within the trust.

CGT

In addition, transferring assets to her children from the trust would be treated as a disposal at market value for CGT purposes. This could result resulting in a significant tax liability if the trust holds assets with substantial unrealised gains. However, holdover relief can defer the CGT by passing the gain to the beneficiaries, the children inherit the trustees' base cost, so no immediate CGT liability arises. The gain only crystallises when the beneficiaries eventually sell the assets.

Income tax

Any undistributed income within the trust at the point of wind up must be addressed. Income distributed to beneficiaries carries a tax credit at the trust rate of 45%, which basic and higher rate taxpayers can reclaim through their individual self-assessment tax returns.

The Outcome

Following our review, the client decided to wind up both trusts and distribute the assets directly to her children. By timing the distributions correctly, we achieved the following:

Total trust assets distributed

£580,000

IHT exit charges paid

£3,000

CGT deferred via holdover relief

£20,000.

Annual admin costs saved (ongoing)

£3,000 p.a.

A critical planning point in this case was the interaction between IHT exit charges and CGT holdover relief. Understanding this relationship was essential to achieving the best outcome.

Holdover relief under section 260 is only available where the distribution is subject to an IHT exit charge. The relief requires the transfer to be chargeable to IHT – it does not matter whether any IHT is payable, but there must be a charge in principle.

Distributions made within the first three months after an anniversary have no complete quarters elapsed, meaning no exit charge arises and therefore holdover relief cannot be claimed. This can result in an immediate CGT liability that could otherwise have been deferred.

In this case, the trusts held investment portfolios with unrealised gains of approximately £85,000. At the trustee CGT rate of 24%, an immediate tax liability of approximately £20,000 would have arisen if holdover relief was not available. By timing the distributions to ensure at least one complete quarter had elapsed since the relevant anniversary dates, we secured the availability of holdover relief and deferred this liability.

Beyond the winding up of both, we also reviewed her life insurance arrangements. One policy worth £200,000 was not held in trust, meaning the proceeds would have formed part of her taxable estate. We recommended placing this policy into trust, reducing her potential IHT liability by £80,000.

Further recommendations were also made to reduce her estate and IHT position.

Key Takeaways

1. Trusts established many years ago may no longer be the most tax-efficient structure. Regular reviews are essential, particularly following changes to legislation.

2. Winding up a discretionary trust has both IHT, CGT and income tax implications. These need to be balanced carefully to achieve the best overall outcome.

3. Timing is critical. CGT holdover relief requires the distribution to be subject to an IHT charge, so getting the timing right can defer significant tax.

4. Professional advice is important to navigate the rules and ensure the best result for your particular circumstances.

How Can We Help You?

At ASWATAX, we help clients navigate the complexities of inheritance tax and trust planning. Whether you need a one-off review or ongoing advisory support, our experienced team can assist.

Our services include:

• Estate and IHT reviews: Comprehensive analysis of your assets, liabilities, and existing arrangements to calculate your IHT exposure and identify planning opportunities.

• Trust set up and wind-up planning: Managing both setting up and winding up processes of trusts from start to finish, including timing advice, tax calculations, holdover relief elections, and compliance with all reporting requirements.

• CGT holdover relief claims: Preparation and submission of the necessary joint elections between trustees and beneficiaries, ensuring claims are made within the four-year time limit.

• Ongoing trust compliance: For trusts that remain in place, we provide annual tax return preparation, 10-year anniversary calculations, exit charge computations, and Trust Registration Service filings.

• Wider estate planning: Working alongside your solicitors and financial advisers to ensure your Will, trusts, and lifetime planning all work together effectively.

If you have trusts that were established some years ago, or are concerned about your inheritance tax position, contact us to discuss how we can help.