A Guide to Trusts

A trust arises when assets are transferred to trustees who are required to deal with those assets in accordance with the terms of the document creating the trust. A trust can be created by someone in their lifetime or by Will.

Trusts are usually created where it is wished:-

(a)           to transfer assets to a minor or to defer the age at which a person may benefit from or have control of the assets; or

(b)           to provide for successive persons to benefit from the trust assets, e.g. where A will receive the income from the assets during their lifetime and thereafter the capital will pass to B; or

(c)           to allow for future flexibility in deciding who will benefit from a trust. In that instance trustees will be given a discretion as to which, if any, of the beneficiaries specified in the trust shall receive any benefit from the trust; or

(d)           to safeguard assets, e.g. from the possibility of a beneficiary dying or divorcing or to protect those assets from a beneficiary’s creditors; or

(e)           to mitigate tax

Different Types of Trusts

1.       Bare Trusts

                These arise where trustees hold assets for an individual who has an absolute right to that asset. The most common example arises where a parent holds an asset e.g. a bank account on trust for a child until the child attains the age of 18. For all tax purposes the income and capital of the trust assets are those of the beneficiary except where the trust has been created by the parent of a minor in which case the income is usually that of the parent.

2.       Interest In Possession Trusts

                These trusts are also known as a “Life Interest Trusts”. They arise where an individual has a right to the income from the Trust Fund until either they die or a specified event occurs. The person entitled to the income is known as the life tenant. When the life tenant’s interest ceases either another person will become entitled to the trust income or the capital will pass to a specified person or persons known as the remaindermen.

                Where the trust was created prior to 21 March 2006, on the life tenant’s death the capital in the trust is aggregated with the life tenant’s own assets for the purposes of calculating the Inheritance Tax payable on their death. The tax is apportioned pro rata between the Trust Fund and the deceased’s own assets in accordance with their respective values.

After 21 March 2006 where a trust is created (other than by Will) Inheritance Tax will normally be payable both on the creation of the trust and throughout its subsistence in the same manner as applies to a Discretionary Trust (see below).

In the case of trusts created by the Will of persons dying after 21 March 2006 then the Inheritance Tax treatment will normally be the same as applying in respect of trusts created prior to 21 March 2006.

3.       Discretionary Trusts

Discretionary Trusts arise where the trustees are given a discretion as to which of the beneficiaries specified in the trust document shall at any time receive any benefit from the trust. The trustees are normally guided by a letter of wishes in which the person establishing the trust indicates how they would like the trustees to exercise their discretion albeit such letter of wishes is not binding on the trustees.

Discretionary Trusts can be very useful where a person wishes to divest themselves of assets but they have either not yet decided who should benefit or they wish to create a degree of flexibility as to who may benefit in the future.

When a Discretionary Trust is established Inheritance Tax will be payable by the person creating the trust (“the Settlor”) where the value of the assets in the trust, when aggregated with the value of assets which the Settlor has placed into other Discretionary Trusts in the previous seven years, exceeds the nil rate band for Inheritance Tax purposes. Tax is payable at 20% on the excess and where the Settlor dies within seven years of the establishment of the trust then a further 20% tax is payable on their death.

As no person has any right in the Trust Fund no Inheritance Tax is payable when any beneficiary dies. Accordingly, it is a very effective method of allowing assets to pass from one generation to another without the payment of Inheritance Tax. The trust is however liable to an IHT charge on the tenth anniversary following its creation and each tenth anniversary thereafter to the extent that the assets in the trust exceed the nil rate band current at that time. The maximum rate of tax payable on any ten year anniversary is 6%. In addition “exit” charges may be payable when assets are removed from the trust between any ten year anniversary.

For Income Tax purposes the income is normally those of the trustees and is taxable at 40%. For Capital Gains Tax purposes the gain is again normally treated as the trustees and is taxable at 18%. To the extent that income is paid to a beneficiary who does not pay tax at 40% then that beneficiary can recover some of the tax which has been paid by the trustees.

4.       Accumulation and Maintenance Trusts

These trusts relate to a trust created prior to 21 March 2006 where persons will  benefit from the Trust Fund by an age not greater than 25. This is treated in the same manner as a Discretionary Trust for Income Tax and Capital Gains Tax purposes.

5.       Bereaved Minor’s Trusts

These are trusts which arise under the Will or intestacy of a person dying after 21 March 2006 whereby the beneficiary is a minor child of the deceased who will inherit at an age no greater than 18. Such trusts are not subject to the ten yearly charges and exit charges which relate to Discretionary Trusts.

6.       18-25 Trusts

These are trusts established by the Will of a person dying after 21 March 2006 whereby a child of the deceased will inherit at an age not greater than 25. They are liable to exit charges in the same manner as for Discretionary Trusts but the exit charge will not exceed 4.2% of the Trust Fund and, indeed, no tax will be payable unless the total value of all trusts created under the Will exceeds the nil rate band for Inheritance Tax purposes.

Trustees’ duties

The Trustees have a duty to:-

(a)      deal with the trust assets in utmost good faith and in accordance with the provisions of the document creating the trust

(b)      take independent financial advice with regard to the investment of the trust assets and to periodically review the investments under their control

(c)      account for all Income Tax, Capital Gains Tax and Inheritance Tax for which they are liable

(d)      preserve assets of the trust and properly insure the trust assets where appropriate

How can we help?

The Private Client Department of Berwins llp have extensive experience and in-depth expertise in advising on the use of trusts, their establishment and administration.