Now might be an advantageous time to utilise lifetime gifting to reduce Inheritance Tax liabilities, but there is also a broader tax picture to take account of too.
A guide to understand how to use trusts in your wealth planning.
Trusts are a time-honoured method of holding and protecting assets and are thought to date all the way back to the Roman times. Trusts can be deployed to confer tax advantages on either the original owner of the assets or the parties intended to benefit from them. However, trusts are also known for their preventative and defensive qualities as they can be used to ensure the financial security of vulnerable people or to shield family assets from the consequences of divorce, for example. They can be very robustly set up to protect the financial interests of an individual, a family or even an entity like a company or a charity.
(Details correct for the 2014/15 tax year)
By placing assets (which may be money, but also property and other assets like life insurance policies) into trust, the owner of those assets relinquishes some of their rights over them and delegates this responsibility to a trustee. Essentially, the legal ownership of those assets become separated from its equitable ownership, with the former denoting legal title and responsibility and the latter the right to benefit from the asset. Since the original owner of the assets no longer technically owns them, a number of tax mitigation strategies can be brought to bear. More subtly, trust structures can depersonalise wealth to a large degree, making it easier for individuals and families to manage and share assets strategically, without emotions becoming quite as involved as they might otherwise. They can also be a way for a group of people to benefit from a single asset, such as a commercial property.
The party placing the assets into trust is known as the “settlor” and the recipient of the equitable title is known as the “beneficiary”. One of the most common scenarios for using a trust is when the beneficiary is a minor or is deemed to be too immature to handle a significant amount of wealth; equally, they may be someone who is incapacitated either physically or mentally and therefore cannot be simply given the assets outright. In this case, the settlor would arrange for the trustee to manage the assets for the beneficiary in the manner they see as most sensible (the decisions are ultimately the trustee’s, but they will be guided by the settlor’s wishes). Often the trustee will be charged with securing an income for the beneficiary through shrewd investment management, although they may not carry this out themselves. This income stream may be intended to last for the life of the beneficiary; alternatively, the assets held in trust could be used to generate an income for a certain period before being given over to the beneficiary at a later stage. There are several types of trust structure and your eventual choice will be dictated by the situation at hand and what you are trying to achieve by establishing the trust.
A trustee does not have to be a professional (i.e. someone who works for a trust company), but they do need to be someone absolutely trustworthy and competent since they will have a lot of power over the assets you are settling in trust. They will also be responsible for settling the tax liabilities arising from the trust and, since these structures have their own tax regime, many people will prefer to have their trust administered by a professional, paying them annual fees out of the trust’s assets. A common choice for those looking to structure family wealth is for a person to select a professional trustee along with another who is perhaps a family friend who knows all the parties involved. This creates a nice balance of objectivity and personal knowledge of the beneficiaries’ situations.
It is also important to note that one of the trustees you appoint can be yourself, meaning that you can still retain a great deal of control over how the trust is administered. Being a trustee of a trust that you yourself have established is usually most common in the case of revocable trusts, which where the trust’s set-up allows for its provisions to be changed if the settlor so chooses.
One of the most common reasons people wish to establish a trust is to minimise the amount of inheritance tax (IHT) payable on their estate so that they can leave more of their hard-earned money to their family. Since you relinquish ownership of assets placed in trust they no longer form part of your estate and so trusts are a very commonly used wealth planning tool. Since the threshold for IHT is just £325,000 – a level which has been frozen until 2019 – trusts are an option that every affluent individual should be considering if they are keen to keep as much of their money as possible in their family and out of the taxman’s clutches. While simply gifting assets to your children is an option, the seven-year gifting rule means that you would have to live on for seven years after making the gift or inheritance tax could still apply (a lower rate than the typical 40% may apply if you live on for a few years after making the gift, however; your financial adviser will be able to explain all these technicalities). It may also be the case that a large cash gift will cause a significant Capital Gains tax charge to the recipient.
Trusts can be a very useful way to reduce the IHT bill on your estate; they can also be structured in such a way that the person you wish to give assets is not hit with a hefty Capital Gains tax charge as a result of wealth being distributed to them. In fact, a trust structure could be a useful way to manage family wealth overall (and before anyone passes on) as things can be set up so that each beneficiary benefits in a particular way which is most suited to their needs and tax position.
However, while trusts can be a very effective wealth management tool they do carry with them their own tax complexities. Trusts with a value over the £325,000 inheritance tax threshold are subject to a 6% tax charge every decade and while some people have established multiple trusts to get around this rule there have been reports that the government might be moving to end this practice.
Your wealth manager will be able to explain all the trust options available to you and help ensure you choose the optimum strategy for both your own and your beneficiaries’ profile and needs. They are also likely to have an excellent professional network which will make it easy to source the legal expertise you need to establish your trust and have it managed by a professional trust company if that is your wish. Some wealth managers even have a trust arm, since these legal structures are such a useful tool for high net worth individuals and their families.
If you haven’t considered using a wealth manager before – or if you haven’t reviewed your existing manager to check their competitiveness and suitability – use findaWEALTHMANAGER.com to research and find your ideal wealth manager. Then, when you are ready, try our smart online tool.