Some readers have asked about the financial advantages of trusts. Although a few politicians imply that there is something vaguely dodgy about trusts, they offer an entirely legitimate part of personal financial planning available for almost all of us, not just the rich.
You may already have money saved into a trust.
If you are a member of a “defined contribution” pension scheme, the most common type in the private sector,this will often have been written under trust rules with trustees holding the funds on a discretionary basis, meaning they have the power to decide what to do with the money. You will hopefully have left an “expression of wishes” to guide the trustees following your death but ultimately they are the legal owner of the assets.
For tax planning purposes the main types of trusts are bare trusts, wholly discretionary trusts and trusts that give one or more beneficiaries a right to the income. A simple bare trust can be used where you want to split the legal and the beneficial ownership.
For example, if you hold investments through one of the well-known investment platforms you will be the beneficial owner, but the fund shop will have legal ownership. It is the beneficial ownership that matters for tax purposes.
From the day a child is born they have a tax personality. They have a personal allowance for income tax and an annual capital gains exemption.
For example, suppose your parents make an investment as a bare trust for your child with you as the legal owner or nominee on behalf of your children. The income and capital gains made could be received free of tax up to the income tax personal allowance of £12,570 a year as well as the annual capital gains tax allowance. This is currently £6,000 but reducing to £3,000 from April 2024.
Sometimes grandparents will leave assets in trust for their grandchildren in their wills. Parents can also put assets into a bare trust for their children to save CGT but if income is generated above £100 a year it becomes taxed on the parent. For this reason, and the reducing CGT allowance, it probably makes better sense these days to put the funds into an Isa up to the allowance available.
As part of a long-term plan, you may want to skip a generation and pass assets from your parents’ estate on their death into a trust for your children using a deed of variation. This can be an effective way of reducing the impact of inheritance tax but it will leave the £100 income tax restriction above.
As most readers will know, lifetime transfers to an individual are potentially exempt from inheritance tax and fully exempt if made at least seven years before death under the so-called “seven year rule”.
A lifetime transfer into a trust will, however, be chargeable to inheritance tax at a rate of 20pc to the extent that it exceeds the available nil-rate band, currently £325,000 per person. A couple could therefore place up to £650,000 in a trust and, seven years, later repeat the exercise.
Clearly a straight gift to the intended recipient is easier but there are occasions when you may not want to do this. For example, I had many clients who wanted to make gifts to their adult children but were cautious of them going off the rails or of future marriage breakdown. They preferred, as trustees, to retain an element of control over the funds, recognising that they could not benefit personally from this arrangement due to the reservation of benefit rules.
Similar considerations can apply when structuring a will. Couples may want to ensure that the survivor after the first death can have access to the income of the trust but have comfort that on the death of the survivor some or all the funds will pass to their children in preference to a possible second partner. This arrangement in the will is usually referred to by the catchy title of an Immediate Post Death Interest trust.
Inheritance tax 14-year rule
Passing down wealth using a trust can create an anomaly known as the 14-year rule.
This confuses many people because after seven years they had hoped that the taxman would effectively ignore these gifts.
I can best explain this with an example.
Joe, a widower, died last month with assets over £1m. Six years ago, Joe gave his only son £200,000 as a lifetime gift. This followed a £325,000 gift into a trust that he made eight years ago. Since the lifetime gift was within the last seven years it can be caught for IHT even though it is less than the nil-rate band.
This is because the earlier transfer into trust has used up the available nil-rate band. In this example we needed to look back eight years but depending on the circ*mstances, it can be necessary to consider events up to 14 years ago.
If you are interested in taking this further I suggest that you consult a solicitor to help you obtain the best results.
Incidentally, under a recent law change trustees are now required to register when a trust is set up. Solicitors can do this for you but it can also be performed relatively easily online using the Government Gateway.
Mike
Mike Warburton was previously a tax director with accountants Grant Thornton and is now retired. His columns should not be taken as advice, or as a personal recommendation, but as a starting point for readers to undertake their own further research.
