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A Simple Guide to the New £500 Trust Income Exemption

A new rule for trusts will soon be coming into effect, which aims to simplify tax dealings for smaller trusts.

From 6th April 2024, trust beneficiaries will be able to receive up to £500 in income from the trust, without having to pay taxes on it.

However, there are some points that could be a little tricky to get your head around.

This straightforward guide will explain exactly what the £500 trust income exemption is, who it impacts, and how to navigate the changes effectively.

What is the £500 Trust Exemption Rule?

The new rule allows trusts to earn up to £500 in income without paying tax on it.

Sounds simple – but if your trust earns £501 or more, the entire income becomes taxable, not just anything over the £500 threshold.

This “all-or-nothing” approach requires careful planning to maximise the benefit.

Sharing Between Trusts

If the same person has established several trusts, they may need to divide this £500 exemption among all their trusts.

This shared exemption complicates things, especially for those who have set up multiple trusts for estate planning or family wealth management.

The Impact of Rising Bank Rates

When this exemption was first announced, it seemed quite generous, especially with lower bank rates.

However, with current rates now at 5.25%, the real value of this exemption has diminished, affecting how far your trust income can go without being taxed.

Interest in Possession (IIP) Trusts

IIP trusts usually pay 20% tax on income, except for dividends at 8.75%.

With the new exemption rule, smaller trusts won’t need to deal with tax returns or payments for incomes under £500. This will now go directly to beneficiaries, tax-free.

This change is particularly good news for beneficiaries who don’t pay taxes (because their income is below the taxable threshold).

They won’t need to go through the process of reclaiming taxes on the income they receive from the trust.

In other words, they can keep the full amount of income they receive – up to £500 – without having to worry about tax deductions.

However, basic rate taxpayers will need to account for this income on their tax returns.

Previously, the tax credit associated with trust income covered their tax liability, meaning they didn’t need to pay additional taxes on that income.

Discretionary Trusts

In a discretionary trust, taxes are paid at a rate of 45% on most income.

Dividends are the exception to this rule; they are taxed at a slightly lower rate of 39.35%.

This tax rate of 44% matches what an individual in the highest tax bracket would pay.

There used to be a £1,000 standard rate band where lower tax rates applied, but going forward, the £500 income exemption has replaced that band.

Here’s where it gets a little complicated.

Even if the trust qualifies for the £500 exemption, any money given to beneficiaries still comes with a 45% tax credit attached.

So, the trust needs to pay enough tax to cover this credit – which can lead to some pretty complex mathematics.

For the beneficiaries, though, things stay the same. They’ll still have a 45% tax credit on any income they receive from the trust, just like before.

Need Expert Advice on Trusts?

Whether you’re managing a trust or are a beneficiary, staying informed and seeking help when necessary is key to making the most of this new exemption rule.

Our experts are here to help you with all your trust and tax planning needs, providing bespoke solutions tailored to your unique situation.

For personalised advice on how the new trust exemption rules will affect you, get in touch with the knowledgeable team at gbac today.

You can give us a call on 01226 298 298 or send a message via our online contact form for a swift response.