Although they appear to have become less fashionable in recent years, I believe trusts are still one of the most effective methods of reducing one’s exposure to inheritance tax. Not only can the gift reduce exposure at the time, it also allows assets to grow in value outside of the estate.
What is a trust?
A trust is a legal agreement whereby a settlor transfers assets into the hands of trustees to manage on behalf of the beneficiary/beneficiaries. The key roles in a trust are:
Settlor: original owner of the assets who gifts them into trust.
Trustee: the legal owner of the assets once they are in trust. Usually a trust would have three to four trustees. The trustees have the same powers over the asset as a person would. The trustees have an obligation to maintain accurate records and ensure the assets in the trust are distributed as per the wishes of the settlor.
Beneficiary: the person or persons who benefit from the assets. The beneficiary might be too young or be incapable of owning the trust assets outright, or in a position where the trust assets are vulnerable to outside influences (divorce, bankruptcy for example).
Why use a trust?
Trusts are very useful vehicles to pass on assets which might otherwise continue to grow and be subject to inheritance tax in one’s estate. Once you transfer assets into a trust, they no longer belong to you provided certain criteria are met. Chief among these criteria would include the Settlor being unable to benefit from the trust assets after they are settled.
By transferring assets into trust, the Settlor is utilising some or all of their available nil rate band (currently £325,000). Relevant transfers over this amount would be chargeable to inheritance tax at the lifetime rate of 20% however, should the donor survive 7 years from the gift, the nil rate band resets and is available once again on the estate. Therefore, in 7 years, a gift into trust can represent an inheritance tax saving of £130,000.
Sometimes a more attractive purpose of a trust isn’t even financial at all but can be a method of transferring the benefit of assets to future generation whilst maintaining control of said asset. This could be where the beneficiary is vulnerable for any reason be it due to age or disability, or where said beneficiary might be susceptible to losing assets to outside influence such as divorce or bankruptcy. This is because the legal responsibility to the trust assets lies with the trustees, not the beneficiary.
The settlor can instruct, via the deed, or advise, via a letter of wishes, the trustees to distribute the assets as and when the trustees feel beneficiaries are responsible enough to hold the funds outright. It might be this never happens and the trust is held for future generations or, ultimately, a charity. Once again, the flexibility with trusts allows for considerable control over the assets.
What types of trust are there?
There are several types of trust, however the most common types are life interest or discretionary. The main difference between the two lies in the way in which beneficiaries are entitled to income:
Life Interest - Beneficiaries will have a right to income in a share as it occurs.
Discretionary - Beneficiaries have no right to income, the trustees will decide on the level of distributions each year.
The flexibility of a trust means that they can be a mixture of the above dependent on the beneficiary. Furthermore they could begin as one type and migrate to the other when beneficiaries are of an age, as advised in the trust deed.
Considering a Trust? Contact Us Today
If you believe a trust might be right for you, please do not hesitate to contact me using the details below.