How do trusts work?
A trust is an arrangement that allows someone (the ‘settlor’) to give assets to another party (the ‘trustee’) to hold for the benefit of one or more persons (the ‘beneficiaries’).
The settlor can appoint more than one trustee and can include themselves. There can be more than one beneficiary – individuals, a specified group or even a whole family – and they can benefit in various ways. They could receive an income which, for example, may be from renting out a house held in the trust. They could receive capital only that, for example, could be a sum of money or perhaps shares. Alternatively, they could receive both income and capital from the trust. Some may not even benefit at all. When setting up the terms of a trust in what’s known as the ‘trust deed’, the settlor can decide what they want to keep control of themselves and what assets the beneficiaries have a right to.
For a trust to be effective for inheritance tax purposes, the settlor cannot also be a beneficiary and neither can their spouse or civil partner while the settlor is still alive.
What assets can I place in trust?
There is no limit on the amount that can be placed in trust. But be aware that if the value of assets you transfer into trust exceeds your nil rate inheritance tax (IHT) band (currently £325,000) you may have to pay IHT at a rate of 20% on the amount over that £325,000.
Despite what many people believe, it isn’t just one-off cash lump sums that can go into a trust. You can also make regular contributions, perhaps from excess income, or gifting properties or investments. Whether you have to pay inheritance tax or capital gains tax as a result of the contribution(s) will depend on the type of trust, what you contribute and its value – so you should always make sure you understand that before you set up a trust or make the settlement.
Can trusts reduce inheritance tax?
Yes – if the trust you use is effective for inheritance tax purposes. Inheritance tax will also be reduced if you gift assets into a trust and you live for seven years or more after the gift was made. After the seven years the whole value of the asset(s) gifted is not liable for IHT and will no longer count towards the value of your estate. If the value of your estate is smaller, then the potential inheritance bill will be smaller too.
So, if your estate was worth £1m and you put £100,000 in cash into a discretionary trust for your children and grandchildren, that £100,000 will be out of your estate for tax purposes if you survive for at least seven more years, making your estate value £900,000 instead (ignoring any growth).
Another way a trust can help with inheritance tax is if you have a life insurance policy that pays out in the event of your death. If the policy is put into a trust, when you die, the proceeds will pay out to the trust instead of your estate.
Laws and tax rules can change, so having a financial planner on your side can be beneficial as they will keep you up to date with the latest changes.
How can trusts help with asset protection?
Not all trusts are set up to save tax. Many are used for asset protection purposes. Lots of people have someone they care about whom, for any number of reasons, may not be well placed to make good financial decisions. Also, life events such as a divorce or bankruptcy can put family assets at risk. These are areas where a trust can really help.
If you use a trust where the trustees have the ability to decide which of the potential beneficiaries should benefit, when and with how much, then the assets held in the trust should be safe from claims on divorce or from creditors. That would be much less likely to be the case if you’d handed any assets over outright.
And if your concern is how your beneficiary would handle a large amount of money coming to them in one go, the trustees could give them a bit at a time or even pay for things for them directly.
How do I set up a trust?
Specialist advice is vital. There are lots of different types of trusts, which will have different tax treatments and your trust has to match your goals and objectives. You will also need to decide what to put into the trust, what the tax consequences (if any) would be of that and who you would want as the beneficiaries and trustees. All of these potentially difficult decisions and the complexity surrounding trusts will be easier to navigate with your adviser alongside you.
To find out more about trusts, please speak to your financial adviser. If you do not have one, we can arrange for an 1825 Financial Planner to get in touch with you.