Guide to Family Trusts in Inheritance Tax Planning
Writing a will can be complicated, not least because of considerations such as Inheritance Tax.
Families also need to deal with issues like leaving wealth to children who might not yet be of an age where they have the skills to handle their finances independently.
One option is to consider a family trust, which enables you to create terms with an element of in-built protection to safeguard your wealth as you wish.
Here, The Law Firm Group explains a little more about what a family trust is, how it works, and why it could be an ideal solution!
Family Trusts Explained
Trusts aren’t confined to leaving assets to children (although they are often used for this purpose).
In brief, they mean that a settlor manages your assets, according to the terms you stipulate.
The settlor doesn’t hold legal ownership of the assets. Instead, ownership passes over to the trustee or trustees. However, the trustee needs to handle the trust as you have directed.
Details covered within the trust documentation include:
- The nominated trustees.
- The beneficiaries (who receive the income generated).
- How the trustees must operate.
You can set up a trust in many ways and choose how the benefits or income are shared between the beneficiaries.
For example, you can decide that your assets will pass to a child when they reach a specific age. In the meantime, the assets are held in trust.
Alternatively, you might wish for your assets to pass onto children eventually, but ensure they benefit a surviving partner or spouse for the rest of their life.
Setting Up a Family Trust
Trusts can be set up at any time (called a deed of trust), or you can include a provision for a family trust in your will, which comes into force if you pass away.
Another factor is setting out a letter of wishes, which guides the trustee on how you want them to manage the assets held in trust.
This type of guidance isn’t legally binding but can be useful to ensure that a less rigorously controlled trust conforms to your requirements.
If your trustee has a broad amount of flexibility to decide how to share out benefits, for example, they might refer to a letter of wishes to inform how they split that income.
A trustee isn’t normally a direct beneficiary unless named as a recipient.
They can claim expenses involved in managing the trust, and if you appoint a solicitor or accountant as a trustee, they’ll usually charge professional fees for the service.
The position of trustee means that the appointed party is legally obligated to act fairly and avoid making any decisions that aren’t balanced in the interests of all recipients.
Choosing a Trust to Manage Your Wealth
We’re here to talk about family trusts, but it’s worth clarifying that there are several different structures you might wish to consider.
Bare trusts are the simplest, whereby you appoint a beneficiary who has 100% entitlement to the assets once they reach 18.
This trust is most commonly used to protect wealth for a child.
Some of the alternatives are:
- Interest in possession trusts – the beneficiary receives the net income after expenses. After paying taxes and charges, trustees must pass all revenue to the recipient.
- Discretionary trusts – trustees are responsible for determining how income and capital are shared. This trust is used for several recipients, and the trustee decides how to allocate payments, such as covering education costs.
- Accumulation and maintenance trusts are often used for a collective group of recipients, which could be several grandchildren. There are fewer tax advantages available than in the past, but it is another option depending on the scenario.
This list is a snippet of the forms a trust can take, so it is highly advisable to seek legal advice before making any decisions.
The key is to consider what you’re trying to achieve, the nature of your assets, and any caveats in the distribution of your estate, and then select an appropriate family trust with the right structure.
Tax Rules on Family Trusts
It’s fair to say that holding assets in a trust isn’t quite as efficient as it used to be from a tax-efficiency viewpoint.
However, the rules depend on what sort of trust you create, the value of the assets held, and who your beneficiaries are.
If you’re keen to minimise tax exposure, the best action remains to consult a solicitor with an in-depth understanding of how trusts operate and the tax liabilities attached.
Any income or capital gains made in a bare trust are usually considered income or capital gains of the beneficiary.
That can vary if the recipient is a child and a parent receives a secondary income.
Some of the other regulations mean that:
- Income under £1,000 in an accumulation or discretionary trust is taxed at a standard 20% rate, and dividends at the nominal 7.5%.
- The rate increases to 45% for general revenue and 38.1% on dividends if the income exceeds £1,000.
- Earnings generated through property rental, savings interest or trading in an interest in possession trust is taxed at the 20% income and 7.5% dividend rate.
- Trustees pay tax on all dividends received and do not benefit from the annual dividend allowance (currently £2,000).
Trusts have an annual Capital Gains Tax allowance, 50% of the individual allowance per year.
Beneficiaries still need to pay income tax on the earnings received but can offset that against the taxes already paid by the trust on its income.
Inheritance Tax on Assets Held in Trust
The final taxation to factor in is Inheritance Tax – often one of the core reasons for creating a trust or even writing a will!
Again, the charges depend on the type of trust you set up and the value of the assets or wealth gifted into trust.
Lifetime gifts are taxed at 20% Inheritance Tax straight away, on anything over the £325,000 nil rate band. The trust pays a 6% tax bill against the assets every ten years, apportioned for anything withdrawn in the intervening decade.
Should you create a trust and donate wealth into it, there may be additional Inheritance Tax charges if you pass away within seven years.
There are some advantages, specifically for young adults or minor’s trusts. Tax relief is also available for trusts created through a will for a spouse and to support recipients with a physical or mental condition.
As we can see, trusts are multi-faceted, and there are multiple decisions to make in terms of the type of trust, choosing a trustee, planning for tax charges, and the ongoing management of your wealth.
Please get in touch with The Law Firm Group for further information about the benefits and drawbacks of family trusts or help to compare the various options available.