The role of trusts in financial planning
This article looks at what trusts are, why we might recommend them, and how they can assist in meeting your personal financial planning objectives. As it’s an extensive topic, we’ll cover a few key areas, with further articles to follow.
When we’re speaking to clients about trusts, usually the main barrier is that clients are not familiar with them and how they work. A common misconception is that they are hugely complicated or solely for the very wealthy, which doesn’t have to be the case.
In a world where life expectancy is now much longer, where around 50% of marriages end in divorce and a backdrop of an ever-escalating Government deficit (increasing the likelihood of higher taxes on wealth in the future), trusts increasingly have a role to play in protecting against the unexpected.
16th March 2022
Julia Banwell See profile
A trust is simply a holding vehicle for an asset held and controlled by the trustees for somebody else’s benefit (the beneficiary/ies). The asset could be said to be ‘ring fenced’ for those beneficiaries.
In practice, the person who sets up the trust (the settlor/s) places an asset into the trust. This is then managed and controlled by the trustees.
The trustees are the people who control and oversee the trust. Anybody can act as a trustee as long as they are over 18 and have full mental capacity. Often, the person who sets up the trust is also a trustee, to retain an element of control over the assets, unless they have set up the trust through their Will.
The beneficiary(ies) of the trust benefits from the arrangement. For example, they may receive money from the trust (as income or capital lump sums), or they may have the right to occupy a property or rent farmland. Certain trusts give the trustees discretion over how and when these benefits are given to beneficiaries, whilst other trusts can be more fixed in what they intend to do.
We usually recommend clients write a Letter of Wishes with any trust that they establish so that their intentions with regards to the trust assets are clear for the other trustees and to provide an indication of how the trust will develop over time.
Different types of trust are subject to Income Tax, Capital Gains Tax and Inheritance Tax (IHT) in different ways. The rates and allowances vary according to the type of trust and how the beneficiaries stand to benefit from it.
There are many different types of trust, each with different purposes and tax rules. Some of the most common types of trusts are:
- Absolute or bare trusts
- Interest in possession trusts
- Discretionary trusts
- Loan trusts
- Discounted gift trusts
- Discretionary will trusts
- Life interest will trusts
There are many reasons why you might consider a trust; however, some of the key reasons are as follows:
Trusts offer a means of potentially protecting assets for the beneficiary, or the ultimate beneficiaries. For example, an outright gift given to a beneficiary who then divorces or goes bankrupt could be lost. However, if a gift is made into a trust under which a beneficiary has no automatic right to the income or capital, then that gift is much less likely to be taken into account.
Similarly, a trust can allow a surviving spouse to benefit from using your personally owned assets after death and ensure that those assets pass to your children on their subsequent death. As an example, such a trust will protect family assets against a spouse remarrying and reallocating funds elsewhere, thus protecting against a second marriage.
Given the ageing population and the fact that it’s ever more likely that a marriage may end in divorce, we are increasingly finding that we are advising clients who may be getting married for the second time. In these situations, clients usually wish to ensure their second spouse is taken care of for the rest of their life, after which the money will pass to any children from the first marriage.
Another interesting scenario is that assets held in trust will also not usually be assessed when considering a person’s wealth for care fee purposes which may become relevant in later life. This is particularly useful to incorporate into clients’ Wills where they know that their spouse is suffering from health issues.
2) Avoiding probate delays
Usually, after you die, any Inheritance Tax (IHT) and probate fees must be paid before your assets can be distributed in line with your Will. However, as a general rule, the executors of your Will can’t access your assets until probate is granted – so they must find the money to settle any IHT bill from elsewhere. As a trust is separate from your estate, your trustees can immediately access any money held in it and use this money to pay the tax bill and probate fees.
3) Life Assurance trusts
Life assurance policies, held in trust, will usually have the death benefit immediately payable out to the beneficiaries upon production of a Death Certificate. This ensures that the sum assured is distributed to the family more quickly as it will not be necessary to wait for Probate. Perhaps more importantly, as the asset is held in trust, the death benefit payment is received outside of your estate and thus is not subject to IHT. This can be hugely beneficial where large sums assured are involved, for example, to cover a mortgage.
4) Maintaining control
Placing an asset in trust allows the settlor to keep control over the assets, even after it is ‘given away’ to a trust.
A common example is when a parent wishes to pass on the family business, but they wish to ensure they can maintain a degree of control, if needed, or ensure that the family asset is protected (as detailed previously).
Alternatively, suppose a family has a holding of agricultural land which may be subject to development in the future. In that case, they may be happy for one branch of the family to farm the land rent-free, but if it’s developed, they may wish to share the proceeds equally amongst all of their children.
Finally, of course, the beneficiaries may not be old enough to inherit (under 18) or may lack the capacity to manage the trust assets. It may be that the settlor does not want the beneficiary to receive too much in one go and would rather the inheritance be passed out in stages under the guidance of the Trustees. Many clients feel that 18 is too young to receive large amounts of capital outright, so look to provide control over the assets until their children or grandchildren reach the age of 21, 25 or even later in some cases, for example.
It should be noted that whilst a settlor may retain ‘control’ they can no longer benefit personally from the asset once it has been passed into trust unless some certain (reversionary) clauses are incorporated into the drafting of the Trust Deed. However, this tends to be an area reserved for more specialist IHT planning trusts.
5) Saving IHT
Trusts offer a useful way to save IHT without making an outright gift to another person. If you place assets into a trust that you cannot benefit from, those assets will fall outside of your estate for IHT purposes after seven years. Additionally, any growth on the assets will immediately be outside your estate, thus saving a larger amount of tax as time goes on.
6) ‘Locking in or Banking’ valuable IHT reliefs
Assets placed under trust are gifted away at the time of the gift. Therefore, if there are any agricultural or business reliefs attaching to the assets at the time of the gift, these reliefs can be ‘locked in’ meaning the assets often remain exempt from IHT and are not revisited on death. For example, any business property relief that may be available on an asset would be ‘banked’ at the time of the transfer to trust. If that asset is subsequently altered to be non-qualifying under the agricultural or business relief rules, e.g., sold or cashed in, there could be no impact on the IHT position as the proceeds from the sale of the asset in this example remain IHT free.
Trusts can be relatively inexpensive to establish, particularly when this is considered against the level of protection that they and the potential tax savings can bring.
It’s important to seek specialist advice as every client situation is different. We have tried to provide examples here of how things might work, but in practice how you may choose to make use of a trust in relation to your own planning will be very much dependent on your own particular circumstances and what you are hoping to achieve. Please do therefore contact us to discuss any aspect further.