A ‘one size fits all’ solution cannot be used when advising on the appropriateness of a trust. It is crucial that your own personal situation is taken into consideration and expert advice is received when considering the use of a trust and also if being advised to switch from one type of trust to another. Care should also be taken if you are considering adding to an existing trust, as there can be massive tax implications.
Also worth noting is that trusts are not universally recognised in every jurisdiction, so it is important that you take advice before implementing any arrangement.
The subject of trusts can seem complex, involving tax and legal issues. Trusts can be useful not only for inheritance tax planning but also in ensuring money ends up in the right hands at the right time.
A trust is usually set up by an individual, called the “settlor”, who passes control of the assets to the “trustees”, whose job it is to look after them for the “beneficiary” (or beneficiaries).
The majority of trust planning is carried out with insurance-based products (protection plans and single premium bonds which do not directly produce income or capital gains for the individual or trustee), but planning can be carried out with collective investments too. However, you must then deal with the income and capital gains from these investments, hence the reason why single premium bonds are favoured.
I want to look at the two most commonly used trusts: the discretionary trust and the bare trust…
THE ‘BARE’ ESSENTIALS! … BARE TRUSTS
Bare trusts are often used by grandparents who wish to provide for grandchildren who are too young to accept the gift being made.
This is a very rigid type of trust. The trustee has no say in how the capital or income of the trust is distributed. The beneficiary, when age 18 (16 in Scotland) can call for the capital, assets, and income of the trust whenever they want. They are in full control … which can be both a blessing and a curse!
The trustee simply holds the trust property on behalf of the beneficiary; the beneficial interest in the property belongs to the beneficiary and any income or capital gains it generates also belongs to the beneficiary and is taxed as such.
The beneficiary is named at the outset, and once the beneficiary has been named, they cannot be changed. The absence of flexibility with Bare Trusts results in a less complex tax regime for this type of trust.
For inheritance tax (IHT) and capital gains tax (CGT) the beneficiary (not the trustees) is treated as the beneficial owner of the trust assets.
A transfer into a bare trust is a potentially exempt transfer (not a chargeable lifetime transfer) for IHT purposes. Thus no IHT arises if the donor (eg grandparent) survives seven years. However, a CGT liability may arise on the assets transferred (for instance shares).
Discretionary trusts are the most popular type of trust due to the flexibility they offer. Trustees have control over who gets what and when, and beneficiaries can be changed at any time. However, this flexibility comes at a price…
Assets held in a discretionary trust do not form part of any individual’s estate on divorce, bankruptcy or death. This type of trust is therefore subject to 3 types of charge for UK Domiciled Individuals. Namely entry, periodic and exit charges.
If you are deemed UK domiciled and contribute more than the current UK Inheritance Tax nil rate band into a Discretionary Trust you will be liable for a UK Chargeable Lifetime Transfer charge of 20% tax on the amount gifted into the trust that is over the nil rate band. Any other Chargeable Lifetime Transfers made within the previous 7 years are also included when calculating how much of the nil rate band has been used. The nil rate band has been £325k since 2009 (£325,000 per person or £650,000 for a married couple or civil partners).
For instance, if you invest £500k into a Discretionary Trust, which may typically be via an offshore single premium bond, £325k is not taxed but the difference (£175k) is taxed at 20% on entry, resulting in an instant tax liability of £35,000.
To give another example, let’s say you invested £325k into an offshore bond using a Discretionary Trust in 2015. At that point there was no IHT charge payable as the £325k is within the nil rate band. Lets imagine that in 2020 you decide to invest a further £200,000 into the Discretionary Trust. Because the second investment has been made within 7 years of the original investment, the original amount is effectively ‘retested’ and so a total of £525k is tested for a Chargeable Lifetime Transfer. This would result in an instant tax charge of 20% on the difference between £525k and £325k nil rate band, namely £40,000 (£200k x 20%).
If the settlor dies within seven years of making the transfer, a further liability to inheritance tax may arise. So caution and expert advice is needed when considering the amount and timing of investments into a Discretionary Trust!
The value of the trust must be checked to see if any IHT is due on every 10th anniversary until all the assets have been distributed to beneficiaries. Calculating the value can be complex but broadly the trustees value the fund then deduct the nil rate band available to the trust, and the balance will be taxed at 6%.
The calculations for the Inheritance Tax exit charge are complicated and relate to Chargeable Lifetime Transfers made in the 7 years before the trust in question was set up. There will be a different calculation depending on whether the transfer out of the trust occurs during the first 10 years of a trust’s life or after the first 10 years. A transfer out includes a number of scenarios, the most common being:
the trust comes to an end (dissolved/wound up)
some of the assets within the trust are distributed to beneficiaries
Tax payable will depend on how the underlying trust assets are held. Assets are often held in an insurance product (e.g. a single premium bond). There is a standalone income tax charge to consider when a chargeable event arises on a single premium bond held in trust. Again the tax can be complex and is different for each type of underlying asset and can be linked to either the settlor, the trustees or the beneficiaries depending on the extent to which they receive benefits from the trust and other things.
If you’re an expat and you’re concerned about the fact that your estate may be liable for IHT duties after you’re gone, speak to Speed Financial Solutions today – and remember that legislation changes all the time, so have regular reviews of how your affairs are structured to ensure they remain compliant and best suited to the task in hand.
If you would like assistance from us contact firstname.lastname@example.org
Speed Financial Solutions are a highly qualified financial services provider looking after clients throughout Spain and the UK. We provide a discreet and comprehensive service to individuals, and our service is tailored to suit your needs taking advantage of tactical opportunities as they arise in respect of your pension planning. We seek innovative solutions for our clients and employ our skills, based on many years of experience, to apply tax legislation to your advantage. Our relationships are built on trust and mutual respect. We are ready to answer your questions, giving you the confidence you want when dealing with a sensitive issue such as discussing your pensions, investments and savings.
Our Principal, Andrea Speed, is a qualified Discretionary Investment Manager specialising in Taxation and Trusts, Investment and Risk, and a qualified Pension Specialist. Andrea is also a Fellow of the Chartered Insurance Institute (CII), which is the world’s largest professional body for insurance and financial services in the world.
Fellowship is the highest qualification awarded by the CII and is universally regarded as the premier qualification. It is a major achievement in the financial industry and demonstrates the acquisition of skills and knowledge at the highest of levels.
Along with a Fellowship, Andrea is a CII Chartered Financial Planner.
Please take a look at our website – www.speedfinancialsolutions.com
For further information contact us on Tel 951 315 271 or 951 318 529
We are happy to discuss your own situation in more detail. One of our advisers would be pleased to spend some time with you either in your home or at our office to review your current savings, investments and pensions, so do call to make an appointment. Our Financial Review is completely free of charge and without obligation. Follow us on Facebook for regular updates.
The contents published are not recommendations or decision aids for your investment decisions and they do not constitute any type of advice. We are not tax advisers and independent tax advice should always be sought.
Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
27 February 2020