Rix & Kay’s specialist trusts and tax lawyer, Bruce Clarke, explains some of the financial trust options available to individuals.
Trusts are still a very important tool when undertaking estate planning – not just because in some situations they offer tax advantages, but because they allow individuals to ring fence assets to be managed by trustees for a specific purpose. Trusts can either be established during an individual’s lifetime or under the terms of their Will and can be tailored to suit individual circumstances.
Why trusts still have a purpose
Trusts are very flexible and can be tailored to meet an individual’s needs and circumstances considering those of the person creating the trust (known as the ‘settlor’) as well as the intended beneficiaries. In some circumstances, it is possible for the settlor to create a trust but still retain the use of the assets in the trust – but this does need careful thought as there are some potentially nasty tax consequences if this is not done properly.
A trust also allows individuals to pass on assets for the benefit of beneficiaries whilst keeping the assets protected from creditors, where there is concern that a marriage will breakdown or from the beneficiaries themselves; some individuals might want their beneficiaries to be able to benefit from the assets but not have control of the assets themselves. It is possible to stipulate that a beneficiary receives a certain part of the trust fund (for example, the income), the entire trust fund on attaining a certain age, or this can be left entirely in the hands of the trustees at their discretion.
Historically, trusts have also been used as a tax planning vehicle although since the overhaul of how trusts were taxed in 2006, the tax advantages of using trusts has become a lot more limited; but there are still advantages in some circumstances.
Some of the types of trust and their uses are explored in more detail below.
Discretionary trusts are a very common type of trust and are often set up for a variety of reasons.
The trustees have complete discretion as to how they distribute the trust fund. The trust deed will specify a few beneficiaries (which can either be individuals, charities or a ‘class’ of beneficiaries – for example, ‘my grandchildren’) and the trustees will decide to which of those beneficiaries (if any) they distribute the trust fund and how much. It is possible for an individual to leave a letter of wishes directing how they would like the trustees to distribute the trust fund, but it is only an expression of wishes and not binding on the trustees.
The flexibility of discretionary trusts mean they are often well suited to many individuals’ circumstances; and they are a great way of protecting assets but allowing beneficiaries to potentially benefit from them later.
However, the tax treatment of these trusts (both when created and ongoing) can be a disadvantage; there are inheritance tax implications for the settlor and the trustees pay a higher rate of income tax (but with planning, this can potentially be mitigated by distributing any income to beneficiaries).
Life Interest Trusts
Life interest trusts are a very useful tool where the settlor wants an individual to be able to benefit from the trust fund during their lifetime (or for a specified period), but ultimately preserving the capital for another beneficiary. They are typically used in Wills by married couples who have married for a second time and have children from the previous marriage.
For example, A and B are married and both have children from a previous marriage. A could include a life interest trust in his Will which would allow B to benefit from the income generated by his estate during her lifetime (which would also allow B to occupy a property) and on B’s death, A’s estate could then pass to his children from his first marriage.
Life interest trusts can be drafted to include some flexibility; for example, allowing the trustees the power to give some of the capital to any of the beneficiaries.
The tax treatment of these types of trust depends on whether the trust is set up during an individual’s lifetime or as part of their Will and in some cases, can prove to be a tax efficient tool in achieving an individual’s end goals.
Excluded property trusts
Excluded property trusts are a very useful vehicle for individuals who are not domiciled in the UK to shelter their overseas assets from inheritance tax.
Assets situated outside of the UK are excluded for inheritance tax purposes whilst they belong to a person who is not domiciled in the UK. Therefore, those individuals who will become domiciled in the UK may be able to protect their overseas assets from inheritance tax once they become domiciled by transferring overseas assets into an excluded property trust. However, the rules relating to domicile and excluded property have been tightened up in recent years and the use of excluded property trusts needs careful upfront planning.
Life policy trusts
It is not uncommon for individuals to assign any benefits payable from life policies to a trust set up during their lifetime. Such policies can be quite valuable and by assigning the benefit of the policy, the proceeds are paid out to the trust rather than the individual’s estate; reducing the overall potential inheritance tax bill.
Trusts do still very much have a purpose and role in estate and tax planning and when used carefully, they can help individuals achieve their end goals. Trusts help individuals divest themselves of assets for future generations whilst offering the settlor some peace of mind knowing that the assets are protected in the long run.