A Trust is a legal arrangement between a ‘Settlor’ and ‘Trustees’. Trustees hold certain assets which previously belonged to the Settlor and use those assets to benefit one or more of the ‘Beneficiaries’.
The details of the arrangement are contained in a legal ‘Trust deed’ document which names the people involved and sets out the terms of the Trust. Trusts may be established while the Settlor is alive but can also be created through a Will.
There are a number of reasons to set up a Trust. It can provide flexible, financial protection for those important to you, making sure that value passes to the people you want it to. It can also benefit future generations in a tax efficient way.
Tax benefits of a Trust
Although some of the tax benefits of Trusts have been reduced in recent years, they are still a useful vehicle for protecting value for the family.
It is usual to have between two and four Trustees overseeing a Trust. Commonly, Trustees are trusted family members or friends of the Settlor but they can also be professionals such as solicitors or accountants to ensure all decisions are made in the best interests of the Beneficiaries.
Trustees are the legal owners of the Trust assets. Their role is to:
If the Trustees change, the Trust will still continue. However, there always has to be at least one Trustee. If the Trust has no living Trustees the Beneficiaries may have to resort to the court to get a new Trustee appointed.
A Beneficiary is anyone who benefits from the assets held in the Trust, this could be a spouse or a whole family, and each Beneficiary may benefit from the Trust in a different way. For example, a Beneficiary may benefit from the income or the capital, or both.
In some cases, the Settlor may also be a Beneficiary of the Trust. These are known as 'Settlor Interested Trusts'.
Grandparents set up a Trust for their grandchild.
They contribute £312,500 cash into the Trust and it is invested into a property producing rental income of £12,500 a year (a 4% return).
The Trust would pay tax of:
£1,000 at a rate of 20% = £200
£11,500 at a rate of 45% = £5,175
Total tax = £5,375
The Trustees (the grandparents) agree to pay school fees for the grandchild of £6,250.
The Trust is treated as paying out £6,250 net of 45% tax:
Gross distribution = £11,364
Tax credit at 45% = £5,114
Net distribution = £6,250
Assuming there is no other income, the tax on the grandchild is nil, based on the distribution of £11,364 as it is less than the personal allowance.
In addition the grandchild is entitled to an income tax repayment of £5,114.
There are several different types of Trust and they each have their own tax implications. The most common types are Bare Trusts, Discretionary Trusts and Interest in Possession Trusts.
A Bare Trust gives the Beneficiary an immediate and absolute right to both the capital and the income.
Although the assets are held in the name of a Trustee, they have no discretion over what income to pay the Beneficiary. Essentially, the Trustee is a nominee in whose name the assets are held, with no active duties to perform.
This Trust exists when a Beneficiary has a current legal right to any income from the Trust as it arises. Often these Trusts are set up in a Will, to benefit a surviving spouse.
The Trustees must pass all of the income received, less any Trustees’ expenses and tax, to the Beneficiary.
The capital will usually pass to a different Beneficiary, or Beneficiaries, at a specific time in the future or after a specific event.
This Trust is effective where couples are concerned about protecting assets for their children. This could be in cases of remarriage, where there are children from an earlier relationship or where there are concerns over the ability of the surviving spouse to handle the assets.
The surviving spouse is able to benefit from the income arising from the assets allowing them to enjoy the same standard of living during their lifetime, without access to free capital. This is protected for the Residuary Beneficiaries (usually the children) who will become entitled on the death of the second spouse.The settlement of the assets on first death does not trigger a charge to IHT. This can also mean that the ‘nil rate band’ is preserved and therefore able to be passed to the surviving spouse. The assets then form part of the estate on second death.
There are a number of circumstances in which IHT may become due for a Trust.
If a Settlor transfers assets worth more than the ‘nil rate band’ (currently £325,000) into a Trust, the excess above the limit can be charged to IHT at 20%.
A Trust has a charge to IHT every 10 years on the anniversary of its creation. A 10 year anniversary charge will be applicable if the value of the Trust is in excess of the nil rate band available at the date of the charge.
The value of the Trust is calculated on the day before the 10 year charge and is the market value of any Trust assets less any debts and reliefs such as Business Relief or Agricultural Property Relief. It also includes the initial value of any other Trusts created by the Settlor on the same day.
Interest in Possession Trusts set up before 22 March 2006 are not subject to these 10 year anniversary charges unless assets have been added to the Trust after this date.
IHT may be due when assets are transferred out of a Trust (known as 'exit charges') or when the Trust ends.
Trusts are subject to different rates of income tax depending on the type of Trust.;