What are Trusts and should I have one (or more)?
STOP PRESS: Probate delays make Trusts a first class planning tool for those who don’t wish their beneficiaries to have to wait a year or more before seeing any cash. Not suitable for everyone though!
So what are trusts?
Trusts were invented by the Courts around the time of the Crusades: Crusaders left their property in the hands of “friends” or family, only to return and then find out they had taken the property as their own. Fortunately, the Courts exercised their discretion (under the doctrine of Equity) and threw out the usurpers. Everyone knew that they were supposed to be acting as caretakers (“trustees”) to look after the absent Crusader’s lands (and often their women!)
So now we have trusts which can be used to shelter assets or property against misuse, to maintain control long after death, and shelter from creditors and taxation.
Trusts can protect assets if beneficiaries are in unstable marriages, in financial difficulties and especially if they are on social services benefits.
Trusts can be created during a person’s lifetime, or in their Will when they die. People often use lifetime trusts when there may be Inheritance Tax issues as you can re-use your Nil Rate Band for gifts every 7 years, so a well off couple could give away £650,000 tax free every 7 years. This is often put into lifetime trusts so that givers can retain control over how it is used and who gets to benefit from it. The Family Bank summarises the benefits of such trusts.
Aside from Life Insurance Trusts, Property Trusts are probably the most common and useful type of trusts.
Types of Property Trusts
-
Protective Property Trusts
These are probably the most common and are suitable for most home owning couples. The idea is to ensure that both partners benefit from the property (or its value) during their lifetime, even if their partner dies many years earlier. I have lost count of the number of times I have had the children of the first to die on the phone asking why they got nothing at all as the surviving partner died and left everything to their new partner or the second or third brood of children.
Protective Property Trusts are also useful in defending the assets of one partner if the other has financial problems or goes into care.
2. Full Property Trusts
A full property trust is created while the owners are still alive, to allow others to manage the paperwork surrounding property ownership and moves. Whilst there is rarely any benefit from the Inheritance Tax viewpoint, the property can be sold and the benefits distributed immediately the original owners are dead. This alone makes such Trusts a must consider for those not to far from the end of their lives.
But did I imply that there were no IHT benefits to full property trusts? Not so – there are IHT saving posibilities for up to 125 years! Not to be sniffed at, but often neglected. All that has to be done is the proceeds are LENT out to the beneficiaries interest free in exchange for an IOU.
Example: inherit £100,000 on a taxable esate – tax on death an extra £40,000. Availbale for the next generation to inherit: £60,000. On the same basis, the third generation would inherit £60,000 less 40% which is £36,000 and so on.
But with a properly used trust, each generation would continue to inherit the full £100,000. An extra £64,000 for the grandchildren. There can be no guarantee the Taxman won’t change the rules one day, but just the stage one benefits – immediate availability of the property to sell or deal with on death rather than waiting commonly a year or more has to be a good thing. It could be sold to pay any IHT bill rather than borowing very large sums to pay it withion the 6 month limit.
A Vital Use 0f Trusts
Trusts are also used to shelter the death benefits of life insurance policies, pensions and death in service benefits. Why? Because the cash will otherwise go either into the estate of the person who has just died, and be immediately subject to Inheritance Tax at 40%. Even if it is directed to the partner of the deceased, that is still going to swell their estate substantially, and attract IHT on their death.
So what a Pilot Trust does is to receive the death benefits and (often) LEND them straight out again to the widow/er interest free. So the partner is in exactly the same cash situation as they would have been otherwise, but their taxable estate has not increased, so the Inheritance Tax payable on death will not be increased because the money has to be repaid to the Pilot Trust, which can then repeat the process for the net generation and beyond.
Who manages a Trust?
A trust is managed by trustees guided by the terms of the trust and often by what is called a Memorandum of Wish (= a letter) from the person who set up the trust. Clearly, appointing sensible trustees is crucial. Most people have family members they can trust implicitly, but it is possible to appoint a professional as Trustee or as a Protector to ensure your wishes are respected.
Tax and Trusts
The Tax Man has cottoned on to the fact that not all trusts are run correctly. Whilst most can be planned to that there is no tax to pay, some overly clever types have been using them for deliberate Tax Evasion so now most trusts have to be registered. Not a big issue, but one potential clients should be aware of.
In general terms it is possible to put up to £325,000 into trust (each partner) without creating a tax charge, but clever planning can ensure that any amount over the Nil Rate Band of Inheritance Tax is in a separate trust without the full benefits – but not triggering an immediate tax charge on investment.
There can be further tax charges on Trusts, so they do need to be correctly set up and run.