If you want to give someone money to benefit either yourself or your family, how can you ensure your assets are distributed according to your wishes?
A Trust is a possible solution by allowing one or more people to control money or assets to benefits a specific person or group.
In a nutshell, a Trust is a way of managing assets, typically through a three-party relationship.
The first party transfers (sometimes known as ‘settles’) property and, on occasion, a sum of money to the second party for the benefit of the third party.
The first party is known as the ‘settlor’ and is responsible for putting assets in a trust, while the second party is the trustee, who has a legal responsibility to care for the assets settled upon them.
This means the third party – which could be an individual, a whole family or specific group of people – is the beneficiary, who is ultimately entitled to the assets.
When you break down a Trust in this way, it’s actually relatively straightforward.
Trusts can often be used to cut down on the amount of tax you have to pay, particularly Inheritance Tax, but they can also protect your assets from falling into the wrong hands.
Similar to a will, a Trust is a legal document into which your wishes can be written.
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What is a Discretionary Trust?
There are several types of Trust although the one of the most commonly used is a Discretionary Trust where the settlor passes discretion as to who benefits from the income and capital of the Trust to the trustees.
Whilst ultimate control rests with them, the settlor can offer a letter of wishes to help trustees.
It’s vital that any trustees take into consideration any wishes included in the document, which is why trustees need to be carefully chosen to ensure these wishes are followed.
Let’s find out how a Discretionary Trust would work in a practical situation.
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In this scenario, Mr and Mrs Smith are retired and living comfortably on their income from their pension and investments.
The couple equally own a property as ‘tenants in common’, worth £800,000, which is included in Mr Smith’s estate (worth £2.3 million) and Mrs Smith’s, which is valued at £500,000.
They have three children – one of whom, Jane, has children and is wealthy in her own right.
Mr and Mrs Smith have Inheritance Tax allowances of £325,000 each. But with Inheritance Tax due at 40% on the excess, the liability is £860,000.
They want to reduce this and retain the right to receiving income to support their retirement.
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They do not qualify for the additional main residence nil rate band, (currently £150,000 each and increasing to £175,000 from April 2020) as their estate is worth more than £2 million.
Mr Smith consults with a wealth planner, who advises him to invest £300,000 into a Discretionary Trust, which provides a right to income of £15,000 per annum.
By placing the money into an Investment Bond, a tax assessment on this income would be deferred for up to 20 years, or until the investment is cashed.
Mr Smith’s planner advises him the Inheritance Tax implications of settling this money into a Trust is an immediate saving of £77,617 and an additional £42,383 after seven years.
As this ‘gift’ reduces Mr Smith’s estate to £2 million, his main residence nil rate band is restored and in seven years there’s an additional saving of £70,000 (ignoring inflation). Overall, he is forecast to save approximately £190,000 or 63% of the gift (the original £300,000 invested).
As the trustees have control of the money, they can lend money to Jane, or gift her share to her children, preventing Inheritance Tax on her estate.
This is not the only benefit of using a Discretionary Trust as it can also be used to plan school fees.
How a Trust can be used for school fees
Mr and Mrs Jones are financially comfortable and have two grandchildren, who they want to provide support for by helping out with school fees. They gift £200,000 into a Discretionary Trust, which is invested into a balanced investment portfolio.
This produces an income of £8,000 per annum on which the Trustees must pay tax, at a marginal rate of 38% (£3,040). Mr and Mrs Jones pay £4,960 towards the school fees with a tax credit of £3,040.
As the beneficiaries have a tax allowance of £12,500 each, no tax is due on the amount received. So, the £3,040 paid by the trustees can be reclaimed.
If Mr and Mrs Jones were also liable for Inheritance Tax, after seven years they also save £80,000.
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Protecting assets following a divorce
Mr and Mrs Peters’ son, Mark, needs £50,000 for a house deposit, which they gift to him.
Unfortunately, Mark gets divorced six years later and his ex-wife makes a claim for half of his estate – including the £50,000 gifted by Mark’s parents.
Had Mr and Mrs Peters consulted with a wealth planner, they may have been advised to arrange a Discretionary Trust into which they would have invested the £50,000.
The trustees could then have loaned the money to Mark to purchase his house. On this basis, they would have created a debt on Mark’s estate, meaning his ex-wife couldn’t make a claim on the £50,000.
Trusts have a range of benefits and when structured with care, settlors can influence assets placed in them.
Of course, financial advice should be sought and, in some cases, legal advice if the situation is complex.
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