News & Resources
What is a Trust?
This note will be of interest to:-
- People who wish to minimise Tax paid on their death
- People who wish to protect and or maintain control over their assets
- People who wish to protect loved ones who are young or vulnerable
- People who wish to protect assets they are giving to their children from the effects of the Divorce Laws or the re-marriage of a wife or husband after their death
- People who wish to protect substantial personal injury damages from tax and the effects of the Divorce Laws.
Why have a Trust?
In this note, Settlors are the people who give the money or asset to the Trust. Trustees hold the assets of the Trust. Trustees hold the assets for Beneficiaries who benefit from the Trust.
1. where the beneficiary is young or irresponsible, or
2. where the beneficiary is married to someone who the Trustees fear will use the Divorce Laws to take assets which were intended for their children or
3. where the beneficiary is vulnerable and needs to be protected ( for example has learning difficulties, addiction problems or mental health issues) Trustees can ensure that funds are available for genuine needs.
4. Where the beneficiary is not good with money and it is feared that they may dispose of all their resources and leave themselves without funds.
5. Where second marriages are involved and conflicting interests arise between security for a surviving spouse and entitlements of children of first marriages.
6. Home Care fee provision.Tax planning
Once the money or asset is validly placed in the Trust, it is no longer in the hands of the person who put it there (‘The Settlor’) but is owned by the Trust.
Trusts are taxed differently to individuals.
Trusts have a tax regime of their own depending on which type of trust is created and the circumstances of the person who put the asset in trust as well as those benefiting from the Trust. For this reason, it is essential to take specialist advice.
The Trustees themselves are treated as a separate tax entity, and may need to complete their own tax returns. They have their own tax exemptions and tax rates, unless they are bare trustees in which case the beneficiaries’ rates and exemptions usually apply.
If a person wants to minimise the Inheritance Tax which they wish to pay on their estate on death (IHT) they can make lifetime gifts. The problem with such gifts is that a person has to survive for 7 years after making that gift for the gift to be effective and free of inheritance tax.
Sometimes people making such gifts (‘The Donor‘) do not wish to make outright immediate gifts to individuals, and a gift to a discretionary trust is very useful, removing the assets from the donor’s estate and setting the seven year period running, but leaving options open as to whom and how much of the money or asset should go.
To be effective, the Donor cannot retain any benefit from the assets put into the trust, although they may be a trustee.
Most trusts have to be registered with the Inland Revenue (HMRC). Bare Trusts do not require registration. Gifts can be made very simply by means of a bare trust without the need to change the legal title to the property. The legal owner simply executes a written Declaration of Trust declaring that they hold the property on behalf of the beneficiary, or jointly with the beneficiary in any specified proportions. This is particularly useful when tax planning with second properties to minimise IHT, though care needs to be taken to ensure that there is no Capital Gains Tax liability triggered by such a gift.
Using Trusts to take “on death” benefits out of your estate
Discretionary Trusts, also known as Relevant Property Trusts (see below), can also be highly tax-effective when used to receive funds from pension death benefits and life insurance policies. When these benefits are designated to be for the benefit of or in trust for beneficiaries, then they will not form part of the donor’s estate for IHT purposes as the funds belong to the trustees rather than the executors of the estate. As with all Discretionary Trusts, it is helpful for the Donor/Settlor to leave the trustees a letter of wishes to guide them when exercising their discretion.
The letter of wishes is not legally binding on the trustees but indicates the Donor/Settlor’s views as to how he or she would wish the trust to be administered by the trustees.
Funds received on death, as well as passing free of IHT, can be made available to beneficiaries without having to wait for a Grant of Probate in the estate, which can be extremely helpful to the beneficiaries.
Personal Injury Trusts
There can also be advantages of putting personal injury claims into a trust. This can relate to tax but there is the danger that a severely injured person who has been given damages to support them to the end of their lives, can be stripped of half of their damages because the Court regard the spouse who was divorcing them as entitled to a part of those damages as a matrimonial asset.
The Main Types of Trust
Relevant Property Trusts (usually Discretionary Trusts)
These can be trusts created during your lifetime or trusts created by your Will (‘Will trusts’).
They enable assets to be given away without having to identify a specific immediate beneficiary. Trustees can have discretion to award funds and assets out of a trust to whoever they wish out of a class of specified beneficiaries.
This enables Trustees to adapt to changing circumstances without any one member of a class of specified beneficiaries having their own “right” to trust assets.
Trusts are usually coupled with a letter of wishes from the donor which serves as guidance to the trustees when exercising their discretion. This type of trust gives great flexibility and can be structured, with specialist legal advice, to protect assets where a beneficiary may be subject to means-testing for other reasons (e.g. care fees, state benefits / Bankruptcy) since the assets legally belong to the trustees and not any beneficiary.
Immediate Post Death Interest Trusts
These Trusts can only be created by your Will and direct that capital and income is to be given in different ways.
For example, a Will can provide for the Trust property to belong to a particular individual (for example a wife) for their life only, so that income from the asset can be paid to a surviving spouse during their life. These trusts can also contain a power for the Trustees to give (or advance) capital if deemed necessary by the trustees. On the death of the person with the Lifetime interest, the capital can then pass to other beneficiaries. These are usually children.
This is particularly useful in second marriage situations or where the person making the will (the ‘Testator‘) wants to protect capital for the children should his wife remarry.
For those who dislike the prospect of war breaking out between their relatives after their death in arguments over money, these trusts can work well in keeping the peace.
These Trusts involve assets being held in the names of trustees on behalf of beneficiaries usually, but not always, because they are under 18 and cannot legally hold the assets in their own name.
As well as protection and preservation of assets, these trusts can, with the right advice achieve tax savings, particularly where the asset has been given by someone other than the child’s parent and advantage can be taken of the child’s own income tax and capital gains tax allowances. Once the child reaches 18, they can call for the funds to be transferred into their name. With appropriate advice, it may be possible to extend further the protection within the trust.
There are other types of trust available which are specifically geared towards disabled/ vulnerable beneficiaries and children.
1. Protective Trusts
2. Disabled Persons Trusts
3. Trusts arising under Wills for beneficiaries who are children
Bereaved Minor’s Trust (S71A IHTA 1984)
18-25 Trust (S71D IHTA 1984).
- In addition, Bare Trusts and Relevant Property Trusts can be used.
1. Charitable Trusts
2. Wills arising by operation of law.
Many people think they only need a simple will without any trusts, but do not appreciate that, where there are beneficiaries who are under 18, trusts will automatically be created and imposed by operation of law.
It is essential to consult a solicitor specialising in this area with a sound knowledge of trust law in order to ensure that the appropriate trust is included.
If this is not done, then the testator’s intentions may not be implemented accurately and there may be undesirable tax consequences.
How is a Trust Created?
- expressly during the settlor’s lifetime
- in a Will
- implied by operation of law (e.g. infants, constructive and resulting trusts)
Trusts can last up to 125 years and need to be carefully worded to cover all eventualities and changes in circumstances, as well as maximising the taxation benefits, therefore specialist advice is essential.
Taxation of Trusts
Trusts are not a free ride out of tax liability.
HMRC expect to receive some payment, even if it is not as much as they would have collected without the Trust being in place.
Inheritance Tax (IHT) may be payable:-
1. when the trust is created
2. every 10 years under the Relevant Property Trust regime (Discretionary Trusts) – maximum 6% ( Only if the trust is over the given nil rate band for that tax year)
3. when capital leaves the trust and/or the trust is brought to an end. ( Only if the trust is over the given nil rate band for that tax year)
The taxation of trusts is complicated. However, there are exemptions and reliefs available and, with correct planning and advice, there can be significant tax savings.
Capital Gains Tax (CGT) may be payable on the initial gift into the trust. CGT is payable on sales and transfers of assets and if the gain (the difference between what the asset was purchased for and what it was sold or transferred for) (“crystallised”) exceeds the donor’s annual exemption (unless the trust arises on death). This also happens when assets are sold by the trustees or the trust is brought to an end.
The trustees have their own annual exemption, which is one half of the individual exemption, and the beneficiaries’ annual exemptions apply in relation to bare trusts. With the right advice, potential CGT can be mitigated significantly
Income Tax (IT) may be payable by the trustees on trust income though, where that income is due to a beneficiary as of right (e.g. with an IPDI or Bare Trust) the tax is payable at the beneficiary’s rate. In other cases (e.g. with a Relevant Property Trust) the trustee rate is applicable, but any tax paid may be recovered by trust beneficiaries if the income is paid out to them and they are lower or non tax paying individuals.
Trusts can be highly effective and useful vehicles which can be used for protecting and preserving assets as well as saving tax, but it is essential to obtain specialist advice as it is a complex area of law. This note is provided as an introduction and can only be regarded as a basic overview.