Trust & Estate Planning

The person who transfers assets into the Trust, is called the Settlor. They can also be a Trustee. For legal reasons – if you want the Trust to be able to sell property – you should have at least two Trustees up to four. Beneficiaries of Trusts can also be Trustees. Trusts can last for up to 125 years and beneficiaries can be added in the future. It is also possible to add assets to a Trust after it has been established.

Should I set up a Trust? 

Trust planning is largely ineffective if the Settlor retains any rights in the property, such as a right to rental income or a right to occupy the property. If the Settlor does retain an interest in the property, then on their death that asset is still counted as part of their estate for IHT purposes.

Transfers into a Trust work best with property that is not mortgaged, because the mortgage lender may have the legal power to block the transfer, (or charge a participation fee); and the trustees may become chargeable to stamp duty land tax (or its equivalent) for having agreed to take over the burden of the mortgage when they take over the property. A similar charge could arise on transfer out as well.

Inheritance Tax

There is an Inheritance Tax charge of 20%, payable when assets are transferred into a Trust.

If you survive for 7 years after transferring assets into a Trust, the value of those assets is excluded from your estate, so you can save 20% IHT (the IHT rate on death is currently 40%). However, if you retain an interest in those assets, their value is included in your estate.

There is no IHT payable on the first £325,000 of someone’s estate, so if you transfer assets into a Trust 20% IHT is payable only on the value of the assets above £325,000 of nil rate band. A surviving spouse can have their late husband or wife’s unused nil rate band added to their nil rate band, taking the amount potentially to £650,000.

Trusts also incur 10-year anniversary charges.

Broadly, on each 10-year anniversary the Trust is taxed on the value of the Trust less the nil rate band available to the Trust. The rate you pay on this excess is 6% (calculated as 30% of the lifetime rate, currently 20%). If the value of the Trust is less than the nil rate band, there will be no charge.

There is also an Inheritance Tax exit charge whereby IHT is charged up to a maximum of 6% on assets (e.g., money, land or buildings) transferred out of a trust – a transfer out of a trust can occur when the trust comes to an end or some of the assets within the trust are distributed to beneficiaries.

Income Tax

Income realized on assets inside a Trust is subject to income tax. If income is not distributed to beneficiaries then tax is paid by the Trust every year. If beneficiaries receive distributions from a Trust, they will usually be taxed individually on this income. 

Capital Gains Tax

Trusts are taxable entities; however, preferential capital gains rates can be used. Trusts can also offset capital gains and a set amount of ordinary capital losses, while carrying excess loss into future tax years. Trusts can offset capital gains through capital losses, and they can carry over excess losses that go beyond the cap to future tax years. These losses cannot be passed through to beneficiaries.

Payment of IHT

You must pay Inheritance Tax on transfers into a Trust (or out of a Trust known as ‘exit charges’) no later than 6 months after the end of the month the transfer was made. The 10-year anniversary charge can be paid up to 6 months after the 10th anniversary of the date the Trust was set up. There are three steps to paying IHT on transfers into trusts.

• Get your Inheritance Tax payment reference number at least 3 weeks before you want to make a payment by filling in Form IHT122.

• Send Inheritance Tax Account form IHT100 to HM Revenue and Customs (HMRC).

• Pay the Inheritance Tax, either through a bank or building society or by cheque through the post.

Registration of Trusts 

Trusts must be registered with HMRC to comply with anti-money laundering regulations. All trustees are equally legally responsible for the Trust, but you must nominate one ‘lead’ trustee to be the main point of contact for HMRC. The lead trustee will receive the trust’s Unique Taxpayer Reference.

If you require advice or assistance with setting up and registering a Trust, our Private Client solicitors will help you. Please get in touch with us on 020 8240 9018 or submit the enquiry form on our website.

The Tax Implications of the Trusts

What is a Trust? 

A Trust is a legal arrangement between a ‘Settlor’ and ‘Trustees’. Trustees hold certain assets which previously belonged to the Settlor and use those assets to benefit one or more of the ‘Beneficiaries’. The details of the arrangement are contained in a legal ‘Deed of Trust’ document which names the people involved and sets out the terms of the Trust. Trusts may be established while the Settlor is alive but can also be created through a Will.

There are a number of reasons to set up a Trust. It can provide flexible, financial protection for those important to you and your family, making sure that value passes to the people you want it to. It can also benefit future generations in a tax efficient way. Although some of the tax benefits of Trusts have been reduced in recent years, they are still a useful vehicle for protecting value for the family.

Type of Trust

There are several different types of Trust and they each have their own tax implications. The most common types are Bare Trusts, Discretionary Trusts and Interest in Possession Trusts.

Bare Trust

A Bare Trust gives the Beneficiary an immediate and absolute right to both the capital and the income. Although the assets are held in the name of a Trustee, they have no discretion over what income to pay the Beneficiary. Essentially, the Trustee is a nominee in whose name the assets are held, with no active duties to perform.

Discretionary Trust

The most common type of Trust is a Discretionary Trust. This type of Trust provides the widest powers and flexibility to the Trustees. Trustees generally have ‘discretion’ about how to use the income and the capital of the Trust. They can decide how much is paid to each Beneficiary, if any, and how often the payments are made.

Discretionary Trusts allow Trustees to take account of changes in circumstances, which the Settlor could not reasonably have foreseen. Depending on the terms of the Trust deed, the Trustees may be allowed to accumulate income within the Trust for as long as the law allows, rather than pass it to the Beneficiaries. Income that has been accumulated becomes part of the capital of the Trust.

The Settlor can exert some measure of influence over the actions of the Trustees through a ‘letter of wishes’ which contains the current wishes of the Settlor concerning the Trust administration. For example, it may specify which Beneficiaries should be financially supported first or the nature of any investments made by the Trustees. However, this is not legally binding.

Interest in Possession Trust

This Trust exists when a Beneficiary has a current legal right to any income from the Trust as it arises. Often these Trusts are set up in a Will, to benefit a surviving spouse. The Trustees must pass all of the income received, less any Trustees’ expenses and tax, to the Beneficiary. The capital will usually pass to a different Beneficiary, or Beneficiaries, at a specific time in the future or after a specific event.

This Trust is effective where couples are concerned about protecting assets for their children. This could be in cases of remarriage, where there are children from an earlier relationship or where there are concerns over the ability of the surviving spouse to handle the assets.

The surviving spouse is able to benefit from the income arising from the assets allowing them to enjoy the same standard of living during their lifetime, without access to the capital of the Trust fund. This is protected for the Residuary Beneficiaries (usually the children) who will become entitled on the death of the second spouse.

The settlement of the assets on first death does not trigger a charge to IHT. This can also mean that the ‘nil rate band’ is preserved and therefore able to be passed to the surviving spouse. Although the assets then form part of the estate on second death, this is only for the purpose of calculating IHT. The Trust assets pass in accordance with the terms of the Trust, not the will of the surviving spouse.

Inheritance Tax

Under existing legislation, it is possible for a husband and wife to put two times the nil rate Inheritance Tax (IHT) band (currently £650,000 in total) of value into a Trust every seven years without immediate IHT costs. With that amount (or greater amounts depending on the value of the nil rate band) protected from future IHT charges for the lifetime of the Trust. The amounts that can be transferred into Trust can be larger where certain business reliefs apply, or the person making the gift has surplus income. As long as the person making the gift survives for seven years after the gift is made, the value of the asset will not be included in their estate for IHT purposes. If they do not survive the period, exemptions may still apply, and increases in the assets value following the gift should continue to be protected from charge.

IHT can also apply when you’re alive if you transfer some of your estate into a trust.

The main situations when IHT is due are

  • when assets are transferred into the trust
  • when the trust reaches a 10-year anniversary of when it was set up (there are 10-yearly Inheritance Tax charges)
  • when assets are transferred out of a trust (known as ‘exit charges’) or the trust ends
  • when someone dies within 7 years of setting up a trust

Trusts are treated differently for Inheritance Tax purposes.

Bare trusts

These are trusts where the assets in a trust are held in the name of a trustee but go directly to the beneficiary, who has a right to both the assets and income of the trust. Transfers into a bare trust will be exempt from Inheritance Tax, as long as the person making the transfer survives for 7 years after making the transfer. With a bare trust, the beneficiary is treated for tax purposes as if they own the property themselves so they should also consider potential income tax and CGT liabilities.

Discretionary Trusts

With this type of Trust, the settlor sets out a list of potential beneficiaries in the trust deed and gives the trustees power to choose who benefits from the trust income/capital, and when. The IHT position for a Discretionary Trust is a 20% charge on assets entering the trust in excess of the settlor’s IHT nil rate band and then 10-year anniversary charges. Deceased spouse’s unused residence nil rate band (RNRB) cannot be transferred when gifting to a trust but it should still be possible to transfer any unused percentage of the normal inheritance tax nil rate band (NRB).

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) e.g. a spouse creates a trust for all the shares they own and the terms of the trust say that when they die, the income from the shares goes to their wife for the rest of their life and when the wife dies the shares pass to the children. The wife is the income beneficiary and has an ‘interest in possession’ in the trust. She does not have a right to the shares themselves.

In many cases the IHT position is the same for interest in possession trusts and discretionary trusts – i.e. a 20% charge on assets entering the trust in excess of the settlor’s IHT nil rate band and then 10-year anniversary charges. Deceased spouse’s unused residence nil rate band (RNRB) cannot be transferred when gifting to a trust but it should still be possible to transfer any unused percentage of the normal inheritance tax nil rate band (NRB)

If you’re valuing the estate of someone who has died, you need to find out whether they made any transfers in the 7 years before they died. If they did, and they paid 20% Inheritance Tax, you need to pay an extra 20% from the estate. Even if no Inheritance Tax was due on the transfer, you still have to add its value to the person’s estate when you’re valuing it for Inheritance Tax purposes.

Excluded property 

Some assets are classed as ‘excluded property’ and IHT is not paid on them. However, the value of the assets may be brought in to calculate the rate of tax on certain exit charges and 10-year anniversary charges.

Types of excluded property can include

  • property situated outside the UK — that is owned by trustees and settled by someone who was permanently living outside the UK at the time of making the settlement
  • government securities — known as FOTRA (free of tax to residents abroad).