Family Protection Trusts are often promoted as a means of avoiding care charges.
We are not convinced on their effectiveness – see the article on our website “Minimising Care Charges”.
We recently came across another issue where a Family Protection Trust caused the potential issue in relation to the Trust.
A Family Protection Trust does not work as an effective Inheritance Tax avoidance measure. If you gift the house into a Trust, but continue living in the house, then for the purposes of Inheritance Tax (IHT) Rules, this is classed as a gift with reservation and the value of the gift would still be included in your Estate (normally your house will be left to your surviving spouse or to your children. If left to a spouse there is no IHT problem here, although if you look at our article on minimising care charges, then we think there is a better alternative and if the house is left to direct descendants, then there is a further additional allowance of £125,000 available where the house is left to direct descendants). However, if you transfer your house into a Family Protection Trust during your lifetime and you die within seven years, then the value of the house will be counted back into your Estate, but as it is no longer part of your Estate at the date of your death the additional IHT allowance is no longer available.
A gift into a Family Protection Trust of a house is part of your IHT lifetime allowance of £325,000.
If you die within seven years of the date of gift, the value of the house is counted back into your Estate – even if you die six years and 364 days after the date of the gift. There is a common misconception that taper relief applies to the value of the gift and the value of the gift is reduced over the seven year period. That is not the case. The taper relief only applies to any tax which has been paid on lifetime gifts. For example, if you had gifted a house with a value of £425,000 into a Family Protection Trust, the value of that gift is £100,000 over your lifetime allowance and you would have paid tax of £20,000. If you die within seven years of having made that gift, then the value of that gift is counted back into your Estate, but depending on where you die within the seven year period a discount may be given to reflect some of the tax that you have already paid.
The legal costs of setting up the trust and transferring the assets into the same would have been significant. That might have been a cost that someone might be happy to bear if the Family Protection Trust had reduced IHT liability however instead the Family Protection Trust actually increased the IHT liability- exactly the opposite of the desired effect!
Consideration of a Family Protection Trust should not be seen in isolation and purely as a means of saving care charges.
There are wider implications to a gift of a house into a Trust and it should be considered as part of an overall Estate/IHT planning exercise. It should not be done without seeking advice on a wider Estate planning basis. It’s a bit like putting double glazing in a house without a roof. Viewed in isolation it sounds like a good idea, but if you look at the overall picture it possibly does not make much sense.
© Alan Livingstone 2019
“If you just focus on the smallest details, you never get the big picture right.”Leroy Hood
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