What Is A Trust, And How Can It Protect Your Family Wealth?

What is a trust?

Likely, you’re really searching for answers to the bigger questions ‘how can I save Inheritance Tax?’ and ‘’can Trusts help with that?’ Well, ‘easily’ and ‘maybe, but there may be better solutions’, are the quick answers

Let’s start with Trusts and work our way through to the ‘better solutions’

What is a Trust?

In its simplest form, a Trust is an arrangement in which somebody is given legal title to an asset and trusted to hold the asset(s) on behalf of the beneficiaries

Trusts were first created around 800 years ago, at the time of the Crusades, and are the original and oldest structures available for legitimate tax and associated planning

Technical Trust terms for everyone to understand

The Settlor is the person who transfers the asset(s) into the Trust. In a real world example, that’s likely Mum or Dad

The Beneficiaries are the people on whose behalf the Trust assets are held, likely the children

The Trustee(s) is the person trusted to hold the asset. That might be Mum or Dad, or a professional Trustee

The key consideration is that the Settlor (Mum or Dad) cannot be a beneficiary (must not be able to benefit) or the Trust will fail for Inheritance Tax planning purposes. Worse, there could be some Capital Gains Tax issues as well

What types of Trust are there?

Types of trusts

Let’s keep it simple, as this part’s heavy going..

For Inheritance Tax planning purposes there are really only two types, ‘Interest in Possession Trusts’ and ‘Discretionary Trusts’

Where a named individual is beneficially entitled, for a fixed period of time, to income or enjoyment of an asset within a Trust, that person has an ‘Interest in Possession’

A Discretionary Trust is broadly any Trust where no person is entitled to an Interest in Possession

What types of Trust might be useful in Inheritance Tax planning?

Let’s start with the jewel in the crown, the Relevant Property Trust

A Relevant Property Trust is effectively treated as a separate person for Inheritance Tax purposes, which means that there is the opportunity to shelter assets outside of your estate

It is possible to create a Relevant Property Trust during your lifetime, and when you die

During your lifetime, you can transfer assets up to the Inheritance Tax nil-rate-band (£325,000 for individuals, £650,000 for married couples or civil partners) every 7 years, and free from Inheritance Tax (and from Capital Gains Tax (CGT)!)

There are ‘anniversary’ and ‘ten-year charges’ to consider but, typically, those are far less than the Inheritance Tax savings

More benefits of Relevant Property Trusts

Both the anniversary, and ten-year charges, are easily dealt with by a skilled tax professional

You can retain control over the assets

Your beneficiaries can have income from the trust, or ‘enjoyment of Trust assets’, while capital remains in the Trust. That may help with a future marriage breakdown for example

As Relevant Property Trust assets are not within anyone’s estate, it means they are not subject to Inheritance Tax in the unlikely event your beneficiaries pre-decease you

It could be a way of passing assets to, say, your grandchildren, if you want to skip a generation

Downsides of other types of Trusts

Downsides of trusts

After you’ve maximised your gifts into Relevant Property Trusts, then any additional gifts into Trust are immediately chargeable to Inheritance Tax, at the ‘Lifetime Rate’ of 20%

Maybe you take the view that 20% is better than 40% (but 0% is best of all, keep reading!)

If you die within 7 years of that gift, the 20% that’s already been paid, is supplemented by a further 20%, bringing the total charged, to the standard 40% Inheritance Tax

Likely, the only reason to take this course of action is a desire to retain control over Trust assets

Typically, younger family members are beneficiaries of the Trust, but the Trust assets are controlled by the Trustees, who are usually older family members

Basic Trusts no longer achieve as much

Since March 2006, Trusts are nowhere near as effective as they once were for Inheritance Tax planning

Up to then, it was possible to transfer unlimited amounts into a Lifetime Trust, without triggering an immediate Inheritance Tax charge

Now, as we’ve seen, there’s a Lifetime Inheritance Tax charge of 20%, levied on transfer of assets to a Relevant Property Trust, to the extent the gift exceeds the donor’s current unused nil-rate-band of £325,000

So, what else may be done?

Alternatives to Trust structures

Well, Family Investment Companies were designed to produce similar outcomes, but without the same tax treatment

While not quite providing the flexibility of Trusts, their structure does separate control from ownership, and that’s key in Inheritance Tax planning

Let’s take a look at creating a (properly structured) company instead

Family Investment Companies and Inheritance Tax planning

Trusts for legacy planning

In reality, it’s nothing more than a company which is set up to hold assets. Those assets are, typically, any type of investment and rental properties

Here’s one of the many possibilities to establish a Family Investment Company

Start by setting up NewCo with, say, £100 share capital, then transfer shares to your (adult) children

Then, transfer your properties to NewCo for an interest-free loan account, payable on demand. The importance of the loan account is you receive full consideration for the transfer, which means no transfer of value has taken place, which means no Inheritance Tax charges can arise

However, there’s a big but, read on..

Family Investment Companies and Capital Gains Tax

While the transaction just described is free from Inheritance Tax, it is treated as a sale at market value for both Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT)

The major downside with this strategy might be the up-front tax costs, which must be paid

On the other hand, you could retain control, and the repayment of the loan account could be used as a tax-free ‘income stream’. Company profits are subject to Corporation Tax at 25%, not Income Tax of up to 45%

There are plenty of planning variations using Family Investment Companies and a skilled tax advisor likely can achieve a tax-efficient solution to most any legacy planning objective.

There’s also plenty of anti-avoidance legislation to take into account!

Let’s look at a couple of examples

Family Investment Companies and structured planning

If the goal is reduction in the value of the estate of the founders of the Family Investment Company, then maybe consider gifting shares (or cash) to your grandchildren. Those gifts are unlimited, and are completely outside of the scope of Inheritance Tax provided you survive for 7 years

Where the gift is in the form of shares, it’s likely there’s merit in considering the value of ‘minority holdings’ for transfer purposes

Family Investment Companies and divorce

Family investments and divorce

The main objective of legacy planning is to protect wealth for the next generation of your family

A Family Investment Company cannot stop a family member getting divorced, but the Articles of Association can be drafted to restrict transfers of shareholdings, and to include compulsory transfer provisions, which can set the value of the shares and, if appropriate, reflect a discount for a Minority Interest

An appropriate Trust holding shares might provide another layer of protection

Be aware that when a shareholder divorces, the court will take into account all their financial resources to determine the appropriate financial settlement

Be sure to take appropriate legal advice, and specialist tax advice

Why not just give it away?

Assets can be passed to other individuals as ‘Potentially Exempt Transfers’ and all you need to do is live for 7 years afterwards, then there’s no Inheritance Tax

It’s simple, it’s effective and, in the right circumstances, it may be a good thing to do

Gifts of money are most efficient. If you gift shares or property, Capital Gains Tax (CGT) will be payable on any increase in value since you acquired them

How to get your Inheritance Tax planning sorted and keep it up to date

The UK has one of the most complex tax structures in the world, with around 18,000 pages of tax laws, and nearly 1,000 tax reliefs and allowances. You can’t know them all. That’s a job for our team of Chartered Tax Advisors (CTA’s)

At outset, we ask you to visualise the future you want for your family legacy then, with our help, work back to today, using informed choices. Our CTA’s provide you with your legacy planning strategy, and all the tools you need to realise your vision

Once your Inheritance Tax planning is finalised, and paid for, you may be invited to become a full member of our Resource Optimisation Program (ROP) where our CTA’s will continue to work with you to aim to maintain everything for you while you’re alive, and they’ll even handle probate for your beneficiaries when you die, if that’s what you want..

ROP provides you with 3 options: our CTA’s will implement, maintain and manage everything, or our CTA’s will work with your existing advisors, or you can do it all yourself. That’s ‘Done for you’, ‘Done with you’ or ‘Done by you’

Contact us HERE to talk to an expert, for FREE!

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