Using Trusts as Part of an Inheritance Tax Planning Strategy

There is a common misconception that trusts are only relevant to, and used by, the wealthy. However, they are accessible to all and can be a useful tool as part of a wider inheritance tax planning strategy.

There are various reasons why a trust may be set up; some can be written into your Will and others can be set up independently. Here we explain what trusts are, what they do and the different types of trust available.

What is a Trust?

A trust is a legal arrangement that enables you to give assets, such as cash, property or investments, to someone else to look after for the benefits of a third party/beneficiary. Once placed in a trust, they no longer belong to you.

Trusts involve three key parties: the ‘settlor’, the person who puts assets into a trust; the ‘trustee’, the person who manages the trust; and the ‘beneficiary’, the person who benefits from the trust.

When choosing your trustee, it’s important to remember that they will have the same powers to buy, sell or invest your assets as you would have before putting the assets into a trust; you must therefore trust this person to manage the trust responsibly and in the best interests of your beneficiary.

Why Use a Trust?

There are several reasons why you may set up a trust:

• To control and protect family assets; for example, to protect the family home from being sold to pay for residential care
• When someone is too young to handle the assets; this allows for money and/or property to be properly managed until children are legally old enough (or reach an age of your choosing) to take possession of them
• When someone can’t handle their affairs because they’re incapacitated
• To provide for your spouse while keeping the estate intact to pass onto your children
• To pass on assets while you are still alive; you can appoint yourself as the trustee, therefore retaining control of the trust and can opt to pay money into it on a regular basis
• To pass on assets when you die (a ‘Will Trust’)
• To reduce inheritance tax liabilities; once in a trust, the assets no longer belong to you, they belong to the trust, removing them from your estate. By reducing the value of your estate, you can reduce the inheritance tax payable upon your death

Types of Trust

The kind of trust you choose depends on what you want it to do. The most common forms of trust are:

• Bare/Fixed/Absolute Trust – the beneficiaries and how much they will receive is fixed when the trust is set up and cannot be changed in the future. If the beneficiary is over 18, they have the right to all the capital and income of the trust at any time.
• Interest in Possession Trust – the beneficiary will receive an income (less any expenses) earned by the trust but does not have a right to the assets that generated that income. They will pay income tax on the income received. An example would be providing an income for your spouse on the understanding that when you die the trust assets will pass to your children. This is popular with people who remarry but have children from a previous marriage.
• Discretionary Trust – the trustees can make certain decisions about how the assets in the trust are distributed, including who the beneficiaries are, what gets paid out (income or capital) and how often. An example would be setting up this trust for your grandchildren and appointing their parents (your children) as trustees to decide how and when the assets are distributed.
• Accumulation Trust – the trustees can accumulate income within the trust and add it to the trust’s capital. As with discretionary trusts, they may also be able to pay income out. These trusts are usually chosen to provide an ongoing income for children.
• Non-resident Trust – where all the trustees reside outside of the UK, they may pay a reduced amount of income tax from the trust, but this will vary depending on whether it’s a discretionary trust or an interest in possession trust and the residence status of the settlors or beneficiaries.
• Mixed Trust – combines elements from the above trust types. The different parts of the trust are treated according to the tax rules that apply to each part.

With each type of trust being taxed differently, it’s important to speak with a qualified professional before choosing which trust is the best for your circumstances. If you would like further advice on setting up a trust, please contact a Finura adviser.

The Financial Conduct Authority does not regulate will writing, taxation and trust advice.

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Sources:
https://www.moneyadviceservice.org.uk/en/articles/using-a-trust-to-cut-your-inheritance-tax#what-types-of-trust-are-there
www.makingawill.org.uk/text-trusts-page-128.html
https://www.gov.uk/trusts-taxes/types-of-trust