Trusts

A comprehensive guide to trusts, what they are and how you can set one up for your family.

Understanding trusts and their implications is crucial for effective estate planning for UK expats and individuals moving to the UK. Trusts are legal arrangements that manage assets for beneficiaries’ benefit. This article delves into the concept of trusts, the parties involved, and the benefits of using trusts, especially for Inheritance Tax (IHT) planning, and addresses common misconceptions.

What Are Trusts?

A trust is a legal arrangement where one party (the settlor) transfers assets to another party (the trustee) to manage for the benefit of a third party (the beneficiary). Trusts can hold various assets, including property, investments, and cash.

Parties Involved in a Trust

1.Settlor: The person who creates the trust and transfers assets into it.
2.Trustee: The individual or organization responsible for managing the trust’s assets according to the settlor’s instructions and in the beneficiaries’ best interests.
3.Beneficiary: The person or people who benefit from the trust. This can be an individual, a group of people, or even a charitable organization.

Reasons for Using Trusts

People use trusts for several reasons, including:

Estate Planning: Trusts can help manage and protect assets, ensuring they are distributed according to the settlor’s wishes.
Tax Efficiency: Trusts can offer tax advantages, particularly for IHT planning.
Asset Protection: Trusts can safeguard assets from creditors, divorce settlements, and other claims.
Control Over Assets: Trusts allow settlors to set specific terms and conditions for how and when beneficiaries receive assets.

Benefits of Trust Planning for IHT

Inheritance Tax (IHT) in the UK can significantly reduce the value of an estate passed on to beneficiaries. Trusts can help mitigate IHT liabilities by:

Reducing the Estate Value: Assets placed in certain types of trusts may not be counted as part of the settlor’s estate for IHT purposes.
Potentially Exempt Transfers (PETs): Gifts made into certain trusts may become exempt from IHT if the settlor survives for seven years after making the transfer.
Control Over Wealth Distribution: Trusts can manage how wealth is distributed over time, potentially reducing the impact of IHT on beneficiaries.

Types of Trusts

1.Discretionary Trusts: Trustees have full discretion over how and when to distribute income and capital to beneficiaries. These trusts are flexible but can be subject to higher tax rates.
2.Bare Trusts: Beneficiaries have an immediate and absolute right to the trust’s capital and income. These trusts are transparent for tax purposes, with the beneficiary being taxed on the trust’s income and gains.
3.Interest in Possession Trusts: Beneficiaries have a legal right to the trust’s income, not capital. The income is taxed at the beneficiary’s rate, while the capital remains in the trust for future beneficiaries.
4.Loan Trusts: The settlor lends money to the trust, which is then invested. The settlor retains the right to have the loan repaid, but any growth on the invested sum falls outside their estate for IHT purposes.
5.Discounted Gift Trusts (DGTs): This involves making a gift into a trust while retaining the right to regular withdrawals. A portion of the gift is immediately exempt from IHT due to the retained benefit, while the rest may become exempt after seven years.
6.Exempt Property Trusts (EPTs): Typically used to hold overseas property, these trusts can help avoid UK IHT on foreign assets.

Taxation of Trusts

Trusts are subject to various tax rules depending on their type:

Income Tax: Trustees may pay income tax on trust income. The rate depends on the type of trust and the amount of income.
Capital Gains Tax (CGT): Trusts may be liable for CGT on the disposal of assets. The rate and allowances for this tax can differ from those for individuals.
Inheritance Tax (IHT): Trusts can incur IHT charges when assets are transferred into the trust, during the trust’s lifetime, and when assets are distributed to beneficiaries.

Common Misconceptions About Trusts

Trusts Remove Assets from the Estate: While trusts can reduce the estate’s value for IHT purposes, certain trusts’ assets may still be considered part of the settlor’s estate.
Trusts Are Only for the Wealthy: Trusts can benefit individuals with varying levels of wealth by providing control, protection, and potential tax advantages.
Trusts Are Complicated and Expensive: While setting up and managing trusts can involve costs, the benefits often outweigh the expenses, particularly in terms of estate planning and tax efficiency.

Property and Trusts

Even if property is held in a trust, it may still form part of someone’s estate for IHT purposes. The specifics depend on the type of trust and the settlor’s control over the property. For instance, if the settlor retains an interest in the property, it may still be included in their estate.

Domicile and Trusts

Domicile is crucial in determining a trust’s tax treatment. UK-domiciled individuals are subject to UK IHT on their worldwide assets. Non-domiciled individuals may only be subject to UK IHT on their UK assets. Understanding and planning around domicile can significantly impact the effectiveness of trust planning.

PETs and CLTs

Potentially Exempt Transfers (PETs): Gifts made during the settlor’s lifetime can be PETs. If the settlor survives for seven years after making the gift, it becomes exempt from IHT. If the settlor dies within seven years, the gift may be subject to IHT on a sliding scale.
Chargeable Lifetime Transfers (CLTs): Transfers into certain trusts are immediately chargeable to IHT. This includes transfers into discretionary trusts. The IHT rate is 20% on the transfer value above the nil-rate band, with potential further charges if the settlor dies within seven years.

Conclusion

Trusts are a versatile and powerful tool for estate planning, offering control, protection, and potential tax advantages. For UK expats and those moving to the UK, understanding the intricacies of trusts and their implications is essential. However, navigating the complexities of trust planning can be challenging without expert guidance. Engaging a financial planner is crucial to ensure that the appropriate types of trusts are selected and implemented effectively. Financial planners can provide personalized advice, considering tax implications, domicile considerations, and individual circumstances. By utilizing trusts under the guidance of a financial planner, individuals can effectively plan for their and their beneficiaries’ futures, ensuring that assets are managed and passed on in the most efficient and controlled manner possible.

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