Trusts - The Advantages and Disadvantages

There are various reasons why a trust would be created by an individual (known as a settlor) planning to pass assets to trustees. These are normally:

• Ensuring assets are passed to beneficiaries who are minors, while retaining some control;
• Tax advantages: removing assets from your estate to a trust can then reduce the part of your estate liable to inheritance tax (IHT);
• Passing property to the next generation: this is particularly important if divorce has occurred previously and your family contains children from different marriages.

Trusts can be complicated, but here we outline the basic advantages and disadvantages:

Advantages

Nil-Rate Band: You can pass assets/cash into a trust up to the nil rate band, which is currently £325,000 – anything over this amount will incur lifetime tax payable at 20%. A married couple can therefore pass a total of £650,000 to the same joint trust. If you survive 7 years from the date of the gift, the transfer will not be included within your estate for IHT purposes.

Life Interest Trusts: A Life Interest Trust ensures a life tenant (a person entitled to income generated by a trust) use of an asset while the life tenant is alive, which could include living rent free in a property. On the death of the life tenant the capital is divided among the beneficiaries in the proportions stipulated in the Trust document. This is a useful option if you wish for assets to be passed to children from a previous marriage.

Discretionary Trusts: A Discretionary Trust allows the Trustees to distribute income and capital as they so wish to the beneficiaries, enabling full flexibility. Since the Trustees have a wide discretion about when and how to make payments to beneficiaries, it is vital that you choose Trustees whom you trust and who will work well together.

Business/Agricultural Relief: Any assets in an individual’s estate that qualify for Business Relief and/or Agricultural Relief will pay 0% IHT on the first £2.5million of Business/ Agricultural assets passing into the trust. Any assets exceeding this will receive relief from IHT at 50%. The allowance is transferrable between spouses, taking the allowance to a maximum of £5million for married couples and civil partners. (Any previous transfers qualifying for the relief will need to be taken into account of the limits).

Disadvantages

Chargeable Transfers: Lifetime transfers to discretionary and life interest trusts are chargeable transfers, meaning that IHT could well be payable on entry if the transfer exceeds £325,000, or if the nil rate band has been utilised previously.

Capital Gains Tax: Capital gains tax (CGT) could also be payable if the asset entering the trust is not cash. Depending on the nature of the asset, there are claims that can be made to delay, or ‘hold-over’ the requirement to pay CGT until the recipient has subsequently disposed of the asset.

Tax Returns: Yearly self-assessment tax returns will be required to report and pay the respective income tax to HMRC. Different types of trusts are liable to income tax at different rates: discretionary trusts are liable at 45% on non-savings income and interest, with dividends taxed at 39.35%, and life interest trusts are liable at 20% for non-savings income and interest, with dividends taxed at 10.75%. If a trust has income of less than £500 per annum, no income tax is payable to HMRC, however the CGT position should still be monitored.

Trust Administration: A trust must be registered with HMRC Trust Registration Service within 90 days of creation. This must then be updated with any changes or, if no changes have occurred, confirmation must be sent to HMRC annually.

Ongoing IHT Charges: Throughout the existence of the trust, IHT charges continue to apply on exits from the trust fund (payments of capital from the trust to a beneficiary) and on each 10-year anniversary of the trust’s creation. The calculation for these charges is complex and relies on a number of factors, but it is never more than 6% of the value of the trust exceeding the available nil rate band (usually £325,000).

Our Tax team are qualified to assist in all aspects of trust creation, administration and closure, including the drafting trust deeds, calculating tax charges, preparing and filing annual tax returns and managing distributions to beneficiaries.

If you believe that your estate far exceeds the nil rate bands, contact us on 01732 770660 or at [email protected]

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published. We do not accept responsibility or liability for any actions taken based on the information in this article.