Trusts

Trusts are highly effective inheritance tax planning tools. They can...

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...whilst preserving the IHT savings afforded by the trust arrangement.

Inheritance tax planning is all about avoiding or reducing the amount of tax that is incurred when an individual’s assets are given or transferred from their estate to another individual, a trust or somewhere else. Most inheritance tax planning decisions hinge on whether to make gifts during an individual’s lifetime, on...

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...ouse’s nil rate band – whatever it is at the time of their death - will be increased by 80%. The residence nil rate band (RNRB) can also be inherited.

The executors or administrators of the survivor’s estate must claim the unused transferable nil rate band within two years of the death of the first to die.

A transfer to a bare trust is a Potentially Exempt Transfer (PET). The main advantage of a PET is that there is no limit on the amount or size of gifts that can be made, and there is no lifetime IHT tax to pay. If the donor survives seven years from the date of the gift, its value is excluded from the donor’s estate and there is no IHT to pay (the ‘potentially exempt transfer’ becomes exempt).

Outright transfers to bare trusts are generally quite efficient for inher...

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...means that the person making the gift could be liable to pay CGT on a gifted asset as if they had sold it for more than they paid for it, even though they have made a gift and received no payment or other consideration for it. This seems very unfair so, in some cases, holdover relief is available, whereby the CGT liability is deferred until the recipient disposes of the asset, who is then deemed to have acquired it at the price the donor paid for it (or the value they acquired it at)

Under current legislation, a nil rate band discretionary trust could be created every seven years with no immediate charges to IHT, and the possibility of no subsequent charges.

However, a charge to IHT arises on the value of the settlor’s property in a discretionary trust on every 10-year anniversary and a pro-rata exit charge arises whenever trust property ceases to be classed as ‘relevant property’.

Discretionary trusts are considered to be ‘related settlements’ if they have the same settlor and are created on the same day.

When calculating the settlor’s cumulative total for IHT purposes, transfers made on the d...

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...rsquo; for IHT purposes and may incur an IHT charge of its own.

Discretionary trusts are useful when there is a clear need to remove asset value from an estate, but where the ultimate beneficiary has not been chosen at the time the transfer is made. This is a tax-efficient way to transfer assets that are most likely to appreciate in value, because any capital appreciation does not increase the donor’s estate – any growth belongs to the trust. However, when appreciating assets are placed in a trust, the trust will need to be monitored closely to take advantage of any opportunities to avoid or reduce ten-year anniversary charges and exit charges.

The order in which PETs and CLTs are made can affect the amount of inheritance tax payable. Annual exemptions are used on a st...

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...are more than seven years prior to the donor’s death (making the potential cumulation period 14 years instead of seven).

There is an annual IHT exemption of £3,000, which is especially useful for individuals who do not have, or c...

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...ngement may be lost if the policy has to be cancelled due to a change in the insured person’s circumstances.

There are several issues to consider when deciding on the most appropriate tax wrapper for trust investments in the context of IHT planning. The capital gains tax regime is generally more advantageous where the trust assets are growth-oriented, e.g. shares.

Most taxpayers avoid CGT because their gains are either within their annual CGT exemption, or are elimina...

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...es have the power to advance capital to the beneficiaries, which would be classed as income in the hands of the recipient beneficiary (this was decided in the case of Brodie’s Will Trustees (1933), but in a later case, the court decided to treat a capital advancement as just that – capital. So, it appears that each case would be decided on its merits).

A loan trust allows investors access to their capital while achieving gradual IHT benefits. They are suitable for those who are not willing or able to make significant lifetime gifts.

This is how a loan trust works:

The settlor sets up a discretionary trust and makes an interest-free, repayable on demand, loan to the trustees, who then invest this into an investment bond

No transfer occurs for IHT purposes because the settlor has not made a gift

Any investment growth is hel...

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...for IHT purposes if it does not fall within one of the IHT exemptions

The settlor needs to make provision for what should happen to any outstanding loan amount on their death. If they do not, their personal representatives are under a duty to call in any outstanding amounts and distribute them to beneficiaries. The settlor might not want this

Trustees are liable for any shortfall if, at the time of the final loan repayment, the value of the bond has fallen below the amount due

A DGT allows an investor to make a lifetime gift that may be discounted for IHT purposes and to take a fixed regular income for life.

They are suitable for individuals who are under the age of 90 at the outset, are reasonably healthy, need a regular income, and who wish to make a gift with immediate IHT.

The investor must accept that the income payments are fixed and that, once a DGT is set up, they lose access to the capital.

This is how a discounted gift trust works:

The settlor makes a cash gift or assigns a bond into a discretionary trust or an absolute (bare) trust, under which the settlor has reserved the right to receive fixed capital sums on pre-selected dates

This provides the settlor with regular income until their death, or the bond becomes exhausted, whichever occurs first

The ‘income’ is produced from the 5% capital...

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...e

The settlor must spend the income from the plan; otherwise it will accumulate and increase the size of their estate, negating the purpose of the plan

If the settlor no longer requires income from the plan, they can waive future rights by deed in favour of the beneficiaries, although the value of the waived rights will be classed as a CLT in the case of a discretionary trust or a PET in the case of a bare trust

Capital cannot be distributed to beneficiaries during the settlor’s lifetime

Trustees can make appointments of capital or loans to the settlor’s surviving spouse or civil partner, provided that person is not also a settlor

Trustees can make loans to beneficiaries, rather than distributing capital, and such loans create debts against the recipient beneficiary’s estate for IHT if they are still outstanding on their death

A flexible reversionary trust (FRT) allows an individual to make a lifetime gift for IHT purposes, while retaining the option to receive a flexible payment each year. An FRT is a revert-to-settlor trust, meaning that the settlor’s carved out interest can be defeated by the trustees. This type of ar...

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...

If the settlor dies within 7 years, the whole gift is included in the estate

No established discount at the outset – the settlor is limited to investing up the available NRB to avoid lifetime tax at 20%

There is no 5% tax-deferred withdrawals facility during the settlor’s lifetime

Back-to-back arrangements allow an individual to purchase an annuity on their own life and take out a life policy on their own life under trust. On their death, the annuity has no value for IHT purposes and the life policy will be outside of their estate because it is in trust. ...

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...p>The main advantage of back-to-back arrangements is that they facilitate moving large amounts of capital out of the individual’s estate for IHT purposes. One major disadvantage is that the individual has to been in reasonable health to be underwritten for the life policy.

The main IHT liability for married couples and those in a civil partnership arises on second death when the joint estate is left to their offspring or other beneficiaries.

Life assuranc...

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...donor dies prematurely, but the premiums can add up to a substantial amount if they survive to an old age, and may even exceed the sum assured that the policy is due to produce on death

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Trusts need to be reviewed on a regular basis to ensure that they are still a...

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... review the trust they manage. Reviews by settlers and/or beneficiaries will be done less frequently and usually following a financial review with their adviser.

A trust can continue in the event of the death of a trustee, either because there are other trustees already in place, or because new trustees are appointed unde...

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... policy is valued on a market value basis and tax is based on rates applicable to the relevant beneficiary. However, it will be paid by the trustees of the fund.

It may be appropriate to carry out a review of existing trust arrangements in the event of serious illness. For instance, if a trustee becomes mentally incapable, this ...

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...under a discretionary trust, the trustees may decide to alter the trust’s distribution policy to make provision for that beneficiary’s needs if appropriate.

As mentioned earlier, statutory trusts are almost completely protected from bankruptcy. However, this protection is less complete with non-statu...

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... so as a result. The bankrupt will be considered to be bankrupt at the time if the trust was set up to benefit a relative or a business partner.

Beneficiary reaching age of majority

A beneficiary may become legally entitled to property belonging to a trust on reaching the age of majority.

Emigration

Where the parties to a trust become neither resident nor ordinarily resident in the UK, the tax consequences pertaining to the trust may be quite important. A trust will need to be reviewed to check the possibility of CGT arising on assets held in the trust because, under current legislation, a chargeable gain may crystallise on emigration of trustees.

If the settlor or one or more of the trustees emigrate, there may be tax planning opportunities and a review of the trust is o...

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...rformance of the trust assets, a breach of trust, a trustee unwilling to act as trustee, beneficiaries not being given access to documentation that they are entitled to see, disputes to do with the amounts of income or capital distributed and in what shares, or disputes over whether a person is actually a beneficiary or not.

Beneficiaries can, if they wish, put an end to a trust under the rule in Saunders v Vautier (1841). If all possible beneficiaries are over 18, of sound mind, and are in agreement, and there is no possibility of any further beneficiaries, they can demand the trust property from the trustees, thereby ending the trust.

Economic changes or changes in market conditions may affect investments of all asset classes. Trustees need to keep investments under review to ensure that they continue to comply with the duty of care which is imposed on trustees in respect of investments.

Trustee Act 2000

The most important change arising from the Trustee Act 2000 was the wide powers of investment it gave to trustees to invest funds as if they belonged to them absolutely, subject to a statutory duty of care.

Under this statutory duty of care, trustees must review the trust’s investments from time to time to consider whether, having regard to standard investment criteria set out in the Act, they should be varied. The standard investment criteria cover the suitability of investments for the trust and the need for diversification.

These statutory provisions only apply where the trust deed does not specify trustee investment powers.

Financial Services and Markets Act 2000

This Act provided a new regulatory framework, two o...

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...stees for goods and services provided to their charity over and above their role as trustees, subject to a duty of care

Give the Charity Commission the power to relieve the liability of trustees who act “reasonably and in good faith”

Mental Capacity Act 2005

The Mental Capacity Act 2005 provides a statutory framework to empower and protect vulnerable people who may not be able to make their own decisions. It clarifies who can take decisions and in which situations, and how they should go about this. It enables people to plan for a time when they may lose capacity.

Needless to say, it is important to understand the terms of the Act and assess its impact on any existing and prospective trust arrangements.

Economic changes

Economic changes or changes in the market may affect the investments held within a trust to the extent that it may become difficult to fulfil the objectives of that trust. Trustees must keep investments under review to ensure they are fulfilling their duty of care.

Have there been any taxation changes that may require the investments to be altered or amended sw...

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...o trustees have to distribute income or capital?

How much flexibility is built into the trust?