The role of trusts in estate planning

• Trusts are one of the oldest financial vehicles in the UK and can be an effective tool for estate planning.

• The process of establishing a trust can seem daunting but it needn’t be.

• However, there are different types of trust with different tax regimes, so good professional advice should be considered.

Trusts date back to the crusades of the Middle Ages, when knights wanted to leave their property somewhere it couldn’t be touched while they were away fighting. But despite this long history, their relevance for financial planning remains bang up to date. Trusts have much to offer people in various situations, whether seeking to pay for long-term care for an elderly relation, or wanting to ring-fence assets earmarked for someone under the age of 18.

What is a trust?

According to the Money Advice Service: “A trust is a way to manage money or other assets for someone else.” [1] But a trust is more than simply a fancy name for a real or virtual safe deposit box. Trusts have a unique legal status, in that they are the only economic entity - other than individuals - that are treated as the ultimate owners of property.

Everything else – companies, partnerships, banks, and their assets – are owned by shareholders or partners and these hold ultimate ownership. [2]

Also, do not let the jargon-type descriptions of those connected with a trust confuse you. The “settlor” is the person who establishes the trust, perhaps to safeguard assets for their children. The “trustee” is the person chosen to manage the trust, and the “beneficiary” or “beneficiaries” denotes the person or people for whose benefit the trust has been established.

It is as straightforward as that.

Trusts as a means to protect your loved ones

A bare trust is the simplest form of trust available. It begins paying out to the beneficiary reaches the age of 18. Alternatively, the Trustees can wind the trust up – that is, close it down – if the trust was designed to hand over all its assets when the beneficiary reaches 18.

A discretionary trust gives the trustee or trustees total authority in the two most important aspects of any trust’s operations. The first is what investments to make and how they are managed. The second is the distribution of the assets and the proportions in which the assets are passed to the beneficiaries. If the settlor has died and can no longer provide guidance, the Trustees will attempt to follow a “letter of wishes”. These should be written by the settlor and should set out to whom and when, and to what extent their chosen beneficiaries could benefit, by the hands of the Trustees.

A discretionary gift trust is a specific variant of this. For IHT purposes, the capital gifted is deemed to have left the settlor’s estate if the settlor survives for another seven years. However, any growth generated within the trust is immediately classed as outside the estate from day one. These trusts can last for up to 125 years and can allow many generations to benefit.

A “trust for a vulnerable person” is a special category of trust and is one area where trust planning can be especially useful: protecting those with poor physical and/or mental health ensuring that their financial needs are met during and especially after the life of the settlor. Settlors for orphans, and other vulnerable people can apply for reduced tax treatment but it relies on applying a variety of formulae [3].

Trusts as estate planning tools

A loan trust allows you to put money into a trust whilst retaining the right to call on it at any time. In estate planning terms this puts any capital gains or reinvested income outside of your estate for inheritance tax purposes. But you are effectively giving away the right to the profits or growth. The capital remains part of your estate for Inheritance tax purposes

An interest in possession trust allows the beneficiary to receive any potential income from the trust straight away, for their lifetime but not the right to access the cash, property or investments that generate that income (1). Such trusts are commonly set up so that, for example, your partner can benefit from an income following your death, but the investments within the trust pass to your children when your partner dies.

A discounted gift trust allows you to retain access to a regular income from the fund that can be used to supplement your income shortfall whilst placing the remainder of the assets outside of your estate for IHT saving purposes. These funds are typically held in investment bond investments either onshore of offshore depending on your tax and residency status.

Lastly, if you are the beneficiary of an inheritance you can take advantage of a solution called a deed of variation, but only within the first two years following the death of the person you have inherited money from. By setting up a trust you can effectively put the money outside of your estate immediately for inheritance tax purposes (without having to survive seven years) whilst retaining the ability to access the income and the capital.

Things to consider

When establishing a trust, you should think about whether you want (and are capable) to manage the trust yourself or hand over that responsibility to an independent or professional trustee. Both have their advantages and their disadvantages. The main disadvantage of doing it yourself is that you need to bring yourself up to speed on the legal duties and responsibilities of acting as a trustee. If you elect to have a third party act as trustee you are handing over those control aspects and legal responsibilities.

A major consideration for anyone thinking of setting up a trust is this: once you have ring-fenced the assets they are effectively lost to you. For this reason you might want to consider other ways of reducing your estate for inheritance tax purposes such as gifting money and using other allowances during your life time

Read more: Intergenerational wealth transfer: it’s all the rage

Professional advice can be vital

If all this sounds daunting, don’t be put off. The use of trusts is not some complicated exercise reserved for the elite, but a real-life piece of financial planning that potentially anyone can access.

Two last words on tax. In general, a trust can reduce Inheritance Tax bills, but this will depend on the type of trust and the rules are complicated. HMRC has an on-line guide laying out some of the principles [4]. For example, Capital Gains Tax will be due on assets sold or transferred by the beneficiaries, although some costs connected with running the trust can be deducted.

Many wonder if there is a limit below which settling a trust is simply not worth it? The short answer is: No. Setting up a trust can be beneficial for anyone with assets above the inheritance tax threshold, or simply a need for a trust which will benefit them financially in cases of vulnerability or financial protection. However, you should consider the effects of fees and charges – both in setting the trust up and administering it – in relation to the value of the assets you wish to protect.

Should you pay for professional advice? In the complex trust landscape, with, as have seen, a range of legal and tax regimes to consider, the answer is a definite yes. And some types of trust – for example a discretionary trust, discounted gift trust, or deed of variation trust – cannot be created without professional advice.

This article is provided for information only. Schroders Personal Wealth does not provide managed trust services directly although we can advise on some types of packaged trusts. If a client requires a managed trust, we can introduce them to the Professional Trustee UK Trust Centre in Lloyds Bank Private Banking or to a firm of solicitors experienced in these matters.

Sources:

[1] https://www.moneyadviceservice.org.uk/en/articles/setting-up-a-trust

[2] Peter Warburton; Debt and Delusion; Allen Lane; 1999

[3] https://www.gov.uk/trusts-taxes/trusts-and-income-tax

[4] https://www.gov.uk/trusts-taxes/trusts-and-inheritance-tax