Hidden away in the last budget were some changes to the taxation of trusts that had professional advisors up in arms.

Whilst the Chancellor said the changes would only affect a few, professional advisors were becoming concerned the changes could affect millions of wills and life insurance policies, affect the IHT position of as many as one in ten people and millions of wills would have to be re-written. A lot of lobbying has gone on, the draft finance bill has been published and HMRC have tried to clarify various matters, although some uncertainties still remain.

Trusts have been used as a device to avoid Inheritance Tax. For example, on an estate worth £570,000 there is 40% IHT on the amount above £285,000, making a considerable tax bill of £114,000. Couples can avoid this by setting up a nil-rate band trust which takes £285,000 when the first of them dies. The surviving spouse could have an income from that trust but it would not form part of their estate so that when the second person dies, the proceeds of the trust go to their children and they avoid IHT.

The changes will affect those who die leaving assets of more than the IHT threshold of £285,000 via trusts that aim to protect their wealth for their children. The main trusts affected by the changes are accumulation and maintenance trusts, interest in possession trusts and some life insurance policies that are written in trust.

Accumulation and maintenance trusts are usually set up by grandparents or in wills to provide for children's education but prevent them from getting their hands on the rest of the cash until they are 25. These trusts did not attract IHT. But now parents and grandparents will either have to give the child access to the entire inheritance at age 18 to keep the trust's tax-free status or leave the age at 25 and pay 6% tax every 10 years on everything over the nil-rate band plus 6% when the fund pays out. New trusts would also have to pay 20% IHT on funds over the nil-rate band passed into the trust. Fortunately, you have until April 6 2008 to change an existing trust but it does mean allowing the children to get their hands on the cash at 18.

Discretionary will trusts that are used by spouses to use up both of their nil-rate bands and save up to £114,000 in IHT are unaffected by the changes.

Despite initial fears to the contrary, HMRC have also since clarified that most straightforward term life assurance will not be affected by the changes. This is because a life policy has very little value when the policyholder is healthy, because there is little chance of it having to pay out. However, if you have a life-threatening illness the policy would have a value and you could face a 6% charge on every 10th anniversary of the policy being taken out. Some investment bonds use trusts and they could be hit by new tax liabilities.

Some of the legislation is still unclear with further lobbying going on before the finance bill is published in its final form in June. As the Government has given a two-year window for protecting certain tax advantages in trusts, if you are in a good state of health you should wait until the Finance Bill is made law to see if there are any changes. However, for anyone near death, expert professional advice now is essential.

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