MORE than 1m people will be caught by Gordon Brown’s budget clampdown on trusts despite a partial volte-face.

The chancellor used his budget last month to sneak in swingeing tax penalties on certain trusts used to pass wealth down the generations free from inheritance tax (IHT).

The government claimed that the crackdown would hit only the very rich, but Sunday Times Money sparked a political row when it revealed last week that millions of ordinary families with routine life policies written in trust could be hit.

The government appeared to cave in on Friday when it published the final rules in the finance bill. Existing life policies were specifically excluded, but only if they are not altered.

However, lawyers said that more than 1m people would still be forced to rewrite their wills to avoid tax penalties. They even fear death-in-service benefits, often paid by company pension schemes into trust when workers die, could be subject to penalties.

James Kessler, a leading tax barrister, said: “The clampdown is every bit as bad as we feared. Anyone who passes assets worth more than £285,000 — the starting point for IHT — into trust in their will is going to have to review it. The legal expenses will be enormous, as will the amounts of tax raised by the change.

“The proposal means the virtual abolition of family trusts in Britain. They’ve been used until now to protect the vulnerable, but Treasury officials think trusts are nearly always for tax avoidance. A week’s secondment in any high-street solicitors firm or accountants would teach them better.”

The government also ignored pleas from lawyers to water down the impact on “accumulation and maintenance” trusts. These are popular with grandparents who want to pay grandchildren’s school fees while still retaining some control over the capital. However, children must now be given control of the assets at 18, rather than 25, or face tax penalties.

Chris Whitehouse, a barrister and member of the Society of Trust and Estate Practitioners (Step), said: “The government has decided, against all professional advice, that if parents intend to give their children assets held in trust, they must do so at age 18 rather than 25, or pay a tax penalty. Yet many parents do not want to give their children money until they have completed their studies and are more mature.”

The Treasury insisted on Friday that, following the climbdown on existing life policies, its measures would “affect only a very small number of very wealthy people”.

However, lawyers dispute this. Kessler said: “The government’s estimate that only 20,000 wealthy people are affected is utterly absurd. I don’t know how the Treasury can say it with a straight face. This phoney figure is just an attempt to stifle proper debate and consideration of the most radical tax- raising measure since the raid on pension funds in 1997.”

Tax experts say the trusts affected are widely used by middle England. Mike Warburton of Grant Thornton, an accountant, said: “What really grates is that this hits not only wealthy families who try to avoid tax, but also ordinary middle-class families trying to organise their affairs in a sensible way.”

The crackdown affects two main types of trust — accumulation and maintenance, and interest in possession.

The latter are often set up by a will where someone, say the husband, wants to provide his wife with an income when he dies, and make sure that capital passes to their children on her death.

Following the budget, his assets could be taxed at 40% above the IHT threshold of £285,000 when they pass into trust — the first time for decades that money passing between spouses has been taxed — and the trust itself could face a 6% tax charge every 10 years.

The government said on Friday such will trusts would be able to avoid tax penalties if they changed their terms. But they will have to give the spouse much more control over the assets than under the current rules — and many people will be loath to do this.

John Riches of Step said: “Well over 1m wills are still going to have to be rewritten to ensure spouses are not taxed on their husband or wife’s death if they are left assets in trust.”

Insurers feared that routine life policies would also be hit by the crackdown because they are often written into a type of interest-in-possession trust. However, the government said on Friday: “The new rules will not apply to life-insurance policies entered into before budget day.”

New life policies written in trust could still be hit with a tax charge of up to 6% on the value of payouts above the IHT threshold, but insurers say it may still be worth doing.

With accumulation and maintenance trusts, grandparents typically make a gift into the trust while their grandchild is still an infant. The benefit of giving the money to a trust, rather than making an outright gift to the grandchild, is that the trustees — usually the grandparents and a solicitor — can retain control over the income and capital until the beneficiary’s 25th birthday. After 25, the income has to be paid to the beneficiary, but trustees can retain control of the capital for up to 80 years.

Until the budget, the government treated the initial gift into the trust as a potentially exempt transfer — it was exempt from IHT if the donors lived for another seven years, although there may have been capital-gains tax to pay.

Now, however, a grandparent who sets up a new trust will have to pay 20% tax on the value of the gift above their IHT allowance of £285,000.

However, the tax grab does not end there. The trust will be taxed every 10 years at a rate of 6% above the IHT threshold. So even if your initial gift is below your allowance, any subsequent growth in the value of the trust’s assets could push them into the IHT net.