An important part of your estate preservation process
If you want to mitigate the effects of Inheritance Tax (IHT) on your estate, trusts can be an important part of the process. When you put cash, property or investments in a trust, provided certain conditions are satisfied, you don’t own it any more. This means it might not count towards your IHT bill when you die.
Although trusts can be a cornerstone of effective estate planning, they are complex. For this reason, it is important to seek professional advice when considering trusts.
What is a trust? A trust is a way of managing assets for people. A trust can be seen as a protective shield for your assets and can be established on death or during your lifetime. One of the advantages of setting up a trust in your lifetime is that you can influence who manages the trust, who benefits and when.
It is a legal arrangement where you give cash, property or investments to someone else so they can look after them for the benefit of a third person. So, for example, you could put some of your savings aside in a trust for your children.
There are three categories of people involved in a trust (there may be more than one of each):
Trustee – this is the person who owns the assets in the trust. They have the same powers a person would have to buy, sell and invest their own property. It’s the trustees’ job to run the trust and manage the trust property responsibly.
Beneficiary – this is the person who the trust is set up for – usually someone unable to manage the trust assets for themselves. The assets held in trust are held for the beneficiary’s benefit.
Settlor – this is the person who establishes the trust and/or provides the trust property.
Cash, property or investments If you put cash, property or investments into a trust, provided certain conditions are met, they no longer belong to you. This means that when you die, their value normally won’t be counted when your IHT bill is worked out.
Instead, the cash, investments or property belong to the trust. Once the property is held in trust, it is outside of anyone’s estate for IHT purposes. Another potential advantage is that a trust is a means of retaining control and asset protection for the beneficiary; a trust avoids handing over valuable property, cash or investments whilst the beneficiaries are still relatively young or vulnerable. The trustees have a legal duty to look after and manage the trust assets for the person who will benefit from the trust in the end.
When you set up a trust, you decide the rules about how it’s managed. For example, you could say that your children will only get access to their trust when they turn 25.
Types of trust Some trusts you can write into your Will, while others you can set up right now. Some trusts are subject to their own IHT regimes, and, once assets have successfully been transferred into trust, they are no longer subject to IHT on your death. Others pay Income Tax and Capital Gains Tax at higher rates, so it is important to know what type of trust you have. The kind of trust you choose depends on what you want it to do.
There are a number of different trust options available:
Bare trusts Assets in a bare trust are held in the name of a trustee. However, the beneficiary has the right to all of the capital and income of the trust at any time if they’re 18 or over (in England and Wales), or 16 or over (in Scotland). This means the assets set aside by the settlor will always go directly to the intended beneficiary. Bare trusts are often used to pass assets to young people – the trustees look after them until the beneficiary is old enough.
Interest in possession trusts These are trusts where the trustee must pass on all trust income to the beneficiary as it arises (less any expenses). The beneficiary can receive income from the trust straight away, but doesn’t have a right to the cash, property or investments that generate that income. The beneficiary will need to pay Income Tax on the income received. You could set up this kind of trust for your partner, with the understanding that when they die the investments in the trust will pass to your children. This trust structure is used in Wills for people who remarry, but have children from their first marriage.
Discretionary trusts These are where the trustees can make certain decisions about how to use the trust income, and sometimes the capital. The trustees have absolute power to decide how the assets in the trust are distributed. You could set up this kind of trust for your grandchildren and leave it to the trustees (who could be the grandchildren’s parents) to decide how to divide the income and capital between the grandchildren. The trustees will have the power to make investment decisions on behalf of the trust.
Mixed trusts These are a combination of more than one type of trust. The different parts of the trust are treated according to the tax rules that apply to each part. For example, a beneficiary might have an interest in possession in (i.e. a right to the income of) half of the trust fund, and the remaining half of the trust fund could be held on discretionary trust.
Non-resident trusts This is a trust where the trustees aren’t resident in the UK for tax purposes. The tax rules for non-resident trusts are very complicated. Non-resident trusts are usually ones where none of the trustees are resident in the UK for tax purposes, or only some of the trustees are resident in the UK and the settlor of the trust wasn’t resident, ordinarily resident or domiciled in the UK when the trust was set up or funds added. Domicile usually refers to the country or legal jurisdiction (a state, for example) where someone intends to make their permanent home – you can only have one place of domicile at any given time.
Appropriate trusts for life assurance Taking out a life assurance policy to pay some or all of an Inheritance Tax (IHT) bill can make things easier on your family when it comes time to sort out your estate. It can help protect your home from having to be sold to pay the IHT.
It can also help ensure your gifts to family and friends in the last seven years of your life are protected from this tax, so it can give you peace of mind that you’re not burdening your family and friends with an IHT bill when you pass away.
However, the money could be subject to IHT as it will form part of your estate when you die. For this reason, you could place any life assurance policies in to an appropriate trust. This will enable your loved ones to legally sidestep IHT, and they would not have to give any of the proceeds of the policy to HM Revenue & Customs on your death. Putting life assurance policies into an appropriate trust can also help your beneficiaries avoid probate. This means they could receive the life insurance proceeds without a lengthy legal process.
Reduce or mitigate the tax you’ll pay on your inheritance A trust can be an effective way to reduce or mitigate the tax you’ll pay on your inheritance, but you should obtain professional advice. Money, assets or property you put into a trust isn’t always exempt from Inheritance Tax. It depends on the type of trust you choose to set up to hold the asset.