If you are thinking about estate planning and passing assets to different generations, establishing a trust is one way of ensuring your wishes are carried out in a tax-efficient manner.
According to the latest figures published by HMRC, Inheritance Tax was one of the few revenue-generating taxes that increased in the 2020-2021 tax year. Inheritance Tax receipts increased to more than £5.3 billion in 2020/2021 compared to the previous year (although below their 2018/2019 peak of £5.4 billion). According to HMRC, this increase is likely in part due to the higher number of wealth transfers that took place during this tax year, and the higher than the usual number of deaths, in part due to COVID-19.
Given the higher tax take and increasing asset values, Inheritance Tax planning is becoming relevant to more and more families. When it comes to Inheritance Tax planning, there are a number of options, which are all worthy of consideration in most circumstances. Each has positives and drawbacks, which is the primary reason why taking independent advice tailored to an individual’s precise situations, needs and objectives, is particularly important in this area. Establishing a trust during an individual’s lifetime is one option that is often a suitable solution.
Trusts are one of the older forms of English financial and property law, having started life in medieval England, around the 12th century. Historians will tell you that when knights went off to war, a trust was required to implement the stated will of the knight, while at the same time granting power to the person chosen to manage the knight’s estate in his absence.
Today, trusts are used either to pass assets during an individual’s lifetime or to help determine what happens to someone’s property or assets in the event of their death. Trust arrangements can be particularly useful where large sums of money are involved, or where the family relationships are complicated, for example after divorce or remarriage, or where children and stepchildren are involved. And above all, trusts place controls over who can receive the assets or property, and when they become eligible to receive them.
Lifetime Trusts are useful when individuals wish to ringfence funds for future generations or to make a gift to family members who maybe cannot receive funds due to their age (i.e. if they are under the age of 18). A common use of a trust is to set aside funds to cover university costs or provide a house deposit for younger relatives.
An important concept to consider is that placing assets into a trust, with the intention of being effective for Inheritance Tax purposes, will mean that those funds will be out of reach to the person making the gift, who is known in law as the “settlor”. This means that trusts tend to be inflexible and careful planning is needed to ensure that funds gifted into a trust will not be needed by the settlor in the future. In addition, the monies placed into a trust will not fully leave the settlor’s potential estate for seven years after the date the gift has been made.
When gifts into a trust are made during an individual’s lifetime, there are different types of trust arrangements that can be used. A Bare Trust is a simple form of trust that is often used for beneficiaries (i.e. the person or people nominated to receive funds from the trust) who are under the age of 18. There is no need for decisions to be reached as to who receives funds from the trust, as the beneficiary is established at the outset and once the beneficiary reaches 18, they are automatically entitled to the funds under law.
Discretionary Trusts are more flexible, in that the trust wording establishes a “pool” of potential beneficiaries. This is often all members of the settlor’s immediate family, including grandchildren and great-grandchildren, but excluding the settlor and spouse. This type of arrangement doesn’t specify who receives the trust fund and allows the ultimate destination of the funds to be decided at a later date. This flexibility comes at a price, however, as this type of arrangement is potentially subject to Inheritance Tax charges every 10 years.
In both cases, trustees are appointed to administer the trust. This is often the settlor but other family members, trusted friends or professionals, such as solicitors, can also be appointed. Ideally, there will be at least two trustees, with a maximum of four being appointed. Trustees must ensure the trust is administered correctly, decide how the trust fund is invested, ensure the correct amount of tax is paid and submissions to HMRC are completed, and in the case of a Discretionary Trust, make decisions as to when sums of money are paid to beneficiaries and how much is paid.
The Trustee Act 2000 sets out comprehensive guidance as to how trustees need to act, when they need to take advice from professionals, and how they reach their decisions. Being a trustee is an important role that carries significant responsibility, and therefore careful thought is needed as to who is appointed as trustee when a trust is set up.
While setting up a trust gives you much greater control in determining where your assets will eventually go, they do have some limitations. For instance, they can often carry a higher burden of tax and greater levels of administration.
In the right circumstances, however, Lifetime Trusts can be an efficient way to plan ahead, by ensuring funds are set aside for future generations and potentially reducing the Inheritance Tax burden on an individual’s estate.
But setting up a trust can be complicated, so it’s always worth talking to an experienced professional who can talk you through the process in determining which type of trust is right for you and your family.
If you are interested in discussing estate planning arrangements with one of our experienced financial planners, please get in touch here.
This content is for information purposes only. It does not constitute investment advice or financial advice.
