If you’re considering estate planning, you’ve probably come across terms like “trusts” and “Inheritance Tax (IHT).“
There’s a helpful strategy using trusts that can help lower taxes called the Rysaffe Principle. Let’s see how this principle can work with trusts to protect your assets.
How Do Trusts Play a Role in the Rysaffe Principle?
Trusts are legal arrangements where you, the settlor, transfer assets to trustees who manage them for your beneficiaries. Discretionary trusts incur tax charges, which include periodic and exit charges:
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Periodic charge: Every 10 years, the value of the trust (after subtracting the available nil rate band for the trust and any previous chargeable transfers) is assessed for tax at a maximum rate of 6%.
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Exit charge: If a tax payment is due from the entry or periodic charge, an exit charge applies to any distributions made by the trustees from the trust fund. This rate depends on the previous calculations but will not exceed 6%.
What is the Rysaffe Principle?
A trust can claim only one Nil Rate Band (NRB), usually £325,000, for its ongoing taxation. By creating separate trusts on different days, each one can claim its own NRB, increasing your tax-free limits. Trusts must be made on different days to qualify for their own NRBs, stopping tax authorities from counting them as one big trust. This nil rate band is completely seperate from the nil rate band that you would use in your own Inheritance Tax planning.
Example
Mr and Mrs Smith are successful business owners with a growing company and varied investments. They want to protect her wealth for their children and reduce inheritance tax liabilities, especially with expected increases in the value of their investment portfolio.
If they put £500,000 into one trust, growing to £815,000 over ten years, they would face inheritance tax. The current nil-rate band is £325,000, meaning £490,000 would be taxable after 10 years. The tax liability would be 6%, which equals £29,400.
To improve her estate planning, they used the Rysaffe principle. Instead of one trust, they set up five separate discretionary trusts, gifting £100,000 to each.
Each trust is considered a separate entity for tax purposes and has its own nil-rate band (NRB). However, gifts made to earlier trusts reduce the NRBs of later ones. The first trust has an NRB of £325,000, the second £225,000 (decreased by the previous gift of £100,000), the third £125,000 (due to earlier gifts of £200,000), the fourth £25,000 (due to earlier gifts of £300,000), and the fifth trust has no NRB.
The net effect is that if the five trusts have a collective value of £815,000 after ten years, the periodic charge would be £20,340, saving £9,060.
When Should I Consider Using the Rysaffe Principle?
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High-Value Estates: If your estate is larger than the NRB, using several trusts can lower the inheritance tax for your heirs.
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Large Life Insurance Policies: For significant life insurance coverage, putting these policies in multiple trusts can make payouts more tax-efficient.
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Long-Term Estate Planning: If you expect your estate to grow or plan to establish trusts over time, the Rysaffe Principle can help manage taxes effectively.
What do you think I should keep in mind?
The Rysaffe Principle has its benefits, but it has some things to be aware of:
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Complexity: Managing several trusts requires careful planning. Each trust must be set up on different days to get separate NRBs.
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Cost: Setting up and keeping multiple trusts can increase legal and administrative fees.
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Need for Expert Help: Due to complex tax laws and trust management, consulting a financial advisor or solicitor is essential to ensure proper setup and ongoing compliance.
