Trusts
Trusts have been in use since the Crusaders set off for the Holy Land, leaving their lands in trust. The person creating the trust is known as the settlor, and the people entrusted with managing the property or investments in the trust are the trustees. There may be named beneficiaries, or there may one or more classes of beneficiaries (my children, my grandchildren etc). A beneficiary (for example, the surviving spouse) might be entitled to the income from the trust for their lifetime, while another class of beneficiaries (for example, the children) might be entitled to the capital. If the trustees have discretion over who should benefit from the trust, it is known as a discretionary trust.
A trust can be set up during your lifetime, or it can be set up on your death in your Will. It might have a special purpose, for example to preserve the benefits from a personal injury claim, without losing the right to claim means tested benefits. Sometimes the Courts will create a trust, for the benefit of a child or an incapacitated person. Offshore trusts are used to hold property in a low-tax jurisdiction when people move abroad, to preserve the assets from taxation in the new country of residence.
Trusts have been used widely for inheritance tax planning. It was common before October 2007 to arrange a discretionary trust in your Will, to preserve the nil rate band from inheritance tax, when the first person of a married couple dies. For people dying on or after 9 October 2007 this is no longer necessary, because it is now possible to transfer the nil rate band, which is currently £325,000, to the surviving spouse or civil partner. Nevertheless, there are other reasons why a Will trust may be used, and why it may be advisable to leave it in your Will if you already have one. If the property that it is placed in the trust is likely to grow in value faster than the increase in the nil rate band, then it would make sense to keep the property in the trust. Land that might get planning permission would be a good example of this. Second marriages may be another reason for using a Will trust, to make sure the children from the first marriage receive their inheritance.
The tax situation for onshore trusts is generally less favourable than for individuals. The standard income rate band is generally £1,000, taxed at 20%, and thereafter the tax rate is 50% (42.5% for dividends) from 6 April 2010. When dividend income is distributed from a discretionary trust, the nature of the income changes from dividend to trust income. Beneficiaries receiving trust income will receive a tax credit, which they may be able to claim back depending on their tax status. The capital gains tax (CGT) allowance of £5,050 is half the individual amount, and the CGT rate for trustees is 28% following the emergency budget 2010. There are ways of reducing the taxable income in trusts by using funds that aim to provide mainly capital growth; alternatively an offshore investment bond can be used to defer the tax until a future date when the situation may be more favourable.
Lifetime gifts into trust are a very useful way of reducing inheritance tax, while retaining control over the assets. If the amount transferred into a discretionary trust exceeds the nil rate band, it will be subject to a lifetime inheritance tax charge of 20% on the amount over the nil rate band. To avoid this, gifts into trust should be less than the nil rate band, although there are ways of getting round this, using an Absolute Trust for amounts in excess of the nil rate band. Provided you survive for 7 years after making the gift into trust, the amount will fall out of your estate for inheritance tax, providing the opportunity to repeat the exercise. It gets a bit more complicated than this if you make a chargeable lifetime transfer and then make further potentially exempt gifts within 7 years.
The holy grail of inheritance tax planning is to provide continuing access to income from the trust, while taking the capital out of your estate after 7 years. There are several well established ways of doing this, that are accepted by HMRC. The best known are the Loan Trust and the Discounted Gift Trust. These are available from insurance companies, for example Standard Life, AXA, Scottish Widows, Legal & General, Prudential. They are based on investment bonds for the investment, because of the convenience of this type of investment for tax. There is no need for a tax return, because there is no income from an investment bond. Only when the investment is finally surrendered do you face up to the income tax, in the form of a chargeable gain. This is an area that requires specialist advice, both from a financial adviser and a solicitor with the right experience and qualifications. Because of our connection with solicitors we can offer just such a service.