Safe from Inheritance Tax and safe for children
Here is a typical thought process:-
1. I don’t want to pay inheritance tax
2. I recognise that means giving assets away
3. The sooner I make the gift the greater the likelihood of surviving the necessary 7 years
4. But I’m worried about giving money to the children at the moment
5. And the grandchildren are too young
If that is you, you don’t have an insurmountable problem – if you are prepared to think about trusts.
It is perfectly possible to create a trust which takes assets out of your estate (thoughts 1 and 2) keeps them protected for the children/grandchildren ((thoughts 4 and 5) and because of that can be done as soon as you are ready to part with the cash (thought 3).
A typical thought 6 might be:-
6. I want still to be able to control the purse strings.
More helpful news – you can be a trustee.
Trusts in a nutshell
In brief a trust is an arrangement where one group of people (trustees) hold assets for the benefit of another (beneficiaries). What they do with those assets is dictated by the terms of the trust and the duties imposed by law on all trustees.
Although legally speaking the trustees own the assets they cannot use them to benefit anyone who is not a beneficiary (including themselves). Most importantly the person who puts the assets in (the settlor) will no longer be treated as owning the assets.
Tax – the short point
The transfer to the trust will be taxed as if it is a gift (usual 7 year rule applies), and provided the settlor survives that 7 year period no inheritance tax will be payable – he will have satisfied his original aim (thought 1).
Safe from the family
Although a trust might be for the benefit of ‘the children and remoter issue of the settlor’, it is down to the trustees to decide who gets what and when. The trustees can apply income or capital, or leave both in the trust to grow until needed.
Trustees – who and how many?
‘Who?’ is perhaps the most important question in relation to any trust.
Trustees have two main roles – one to manage the trust fund, and the other to manage its distribution. They must therefore be financially aware, but also sympathetic to the needs of the beneficiaries (if not necessarily always compliant with their wishes).
Family or family friends are often a good place to start, and usually professional advisers will be happy to act. Remember too that the settlor himself can be a trustee as can beneficiaries (provided they can be relied upon to put their duties as trustee ahead of their aspirations as beneficiary).
Only in very rare circumstances should there be less than two. Typically there might be three and we generally advise that trustees must act unanimously – as per the general law.
It is also common for the settlor to write a letter of wishes for the trustees. Trustees usually welcome this as, although not binding on them, it sets out principles to apply when thinking about distributions.
What rights for beneficiaries?
The more ‘rights’ a beneficiary has the less protection the trust affords. Generally beneficiaries’ rights are limited to a right to have the trust properly administered. They can call the trustees to account and ask them to explain what they have done as regards the management of the trust fund, but questioning the exercise of the trustees’ discretion particularly with regard to distributions is something of a non-starter. Nevertheless the trustees can be brought to book if they breach the terms of the trust for example by making poor investment decisions or distributing to people who are not beneficiaries.
As you can see the choice of trustees is critical.
How much can be put into the trust? Or: Tax – the long point
The short answer is as much as you like. But most people will limit themselves to the value of their available inheritance tax allowance – a maximum of £325,000 currently. This is because up to that value there is no inheritance tax on the money going in, and no inheritance tax during the first ten years of the trust. Above that value there is a 20% entry charge – only on that excess – and minor inheritance tax charges on 10 year anniversaries and when assets leave the trust.
But the limit is per person so a husband and wife can contribute up to £650,000 between them. And remember it’s £325,000 every 7 years. A couple in their 60s who live into their 80s could do this 3 times -settling in today’s money £1.95m. And that’s a saving of £800,000 of inheritance tax.
Day to day management and cost
Typically management of a trust will involve the following each year:-
- A tax return, and tax certificates to beneficiaries who receive distributions;
- Meeting to review performance and consider distributions.
Often the trust’s lawyers or accountants will be engaged to take care of tax returns and accounts, but the trustees will have to sign these off, conduct the review of the trust fund and decide on distributions.
Exactly how much a trust will cost to run will depend on how much the trustees involve professional advisers, but it is pretty unusual for a trust not to deliver a substantial pecuniary advantage overall – all that on top of the original practical objective of keeping your money safe.
If you’d like to find out more about trusts and how they might be used either in isolation or as part of a wider estate planning exercise, please get in touch.