TRUSTS
A trust is a device which makes it possible to separate legal ownership of a thing from the right to use that thing or, if it produces income, the right to receive its income. The person who owns the assets in a trust is called a trustee and the person who has the use of the assets is called a beneficiary.
Many people think that trusts have no place in the modern world unless you are very wealthy. However they provide an effective solution, and in many cases the only solution, to many problems that are familiar to all of us.
Here are some examples of how trusts can be useful:
Children
If parents die at an early age leaving small children they will normally want to leave their estate to those children. However the children will be too young to manage the fund and in fact from a legal point of view, they will be incapable of doing so. The fund will have to be held by trustees until the children reach a responsible age. During that time the trustees will look after the investments, they can use the income to help with the children's education and so forth, and they can also advance capital to help the children if they think that the purpose for which it is intended is sensible.
Disabled Beneficiaries
The most effective way to provide for a disabled beneficiary particularly if they are suffering from a mental disability, would be to establish a trust so that trustees will hold the capital and will use the income for the benefit of the disabled beneficiary.
Spendthrift Children
No everyone is good at handling money; we all know families in which one member is constantly getting into financial difficulties. A trust can ensure that the capital that would normally be given to the spendthrift beneficiary is held by trustees who will look after it and can make sure not only that the fund is used to provide maximum benefit for the beneficiary but maybe to preserve the capital so that it might also benefit the beneficiary's dependants.
Second Marriages
John and Mary are married to each other but both have children by their previous marriages. John wants to provide properly for Mary if he dies first but he also wants to ensure that his children by his first marriage get a proper share of his estate.
The solution is for John to leave his estate or part of it in trust for Mary so that she can have the use of the estate or its income for the rest of her life if John dies first. However on Mary's death the capital of the Trust Fund will go to John's children.
Tax Planning
Trusts are often used for tax planning purposes, for example a discretionary trust can enable a beneficiary to have the use of assets or to receive their income without those assets being treated as part of their estate for Inheritance Tax purposes.
Types of Trust
There are three basic types of trust:
Contingent Trusts
Trusts where assets are held on trust for someone until something happens. The most common example of this is where a fund is held for a child until he or she reaches 21 or some other age.
Interest in possession trusts
This is a simple form of trust under which a particular person or persons have a right to have the use of trust assets or to receive their income for a certain period (normally until they die) and then some other specified person or persons are entitled to the capital.
Discretionary Trusts
Under a discretionary trust, instead of there being a particular beneficiary entitled to income and a particular beneficiary entitled to capital, there is a class of potential beneficiaries and the Trustees can allow any member of that class of beneficiaries to receive the income from the Trust Fund or to have the use of assets in the trust. The Trustees can also pay out capital to any member of the class of beneficiaries. A discretionary trust is useful because it provides maximum flexibility.
NIL RATE BAND DISCRETIONARY TRUSTS
A nil rate band discretionary trust is a standard device for reducing inheritance tax.
Often a husband and wife will want to make Wills along the lines that, on the first death, everything passes to the survivor and, on the survivor's death, everything is to pass to the children.
Unfortunately, a simple Will such as this would be inefficient from the point of view of inheritance tax. As you will see from our inheritance tax information sheet gifts between spouses are exempt from inheritance tax so if the nil rate band of the first to die goes to the survivor it is wasted because it is passing to an exempt beneficiary. On the first death no inheritance tax is payable because of the spouse exemption but on the second death all the assets of the couple are bunched into one estate and only one nil rate band is available.
It would be much more efficient if, on the first death, the nil rate band could be given to a taxable beneficiary with the remainder of the first to die's estate going to the surviving spouse. No tax would be payable on the first death and on the second death the estate of the survivor would be reduced by the amount of the nil rate band that went to a taxable beneficiary on the first death. On present figures the saving in tax on the second death would be ,96,800.
However, for most couples the loss of the first to die's nil rate band would leave the survivor short of capital. The current nil rate band is ,242,000 and the survivor is likely to need that capital to provide him or her with income.
A nil rate band discretionary trust is a way of addressing this problem without losing the tax benefit.
A trust is a device which enables you to separate legal ownership of an asset from the right to use it or to receive its income. A discretionary trust is a trust under which there is a class of potential beneficiaries and the trustees can allow any member of that class of beneficiaries to have the use of trust assets or they can pay trust income to any member of that class of beneficiaries. They can also pay capital to any of the beneficiaries.
Under the normal nil rate band discretionary trust the class of potential beneficiaries will include the surviving spouse, children, grandchildren and anyone else whom you might want to benefit.
After the death of the first to die the survivor can receive the income of the trust fund for the rest of their life but, because they did not have an absolute right to receive the income, the value of the trust fund will not be added on to the survivor's estate for the purpose of calculating inheritance tax on the survivor's death.
A great advantage of a discretionary trust is that it is extremely flexible. If, on the first to die's death, it seems that the trust is no longer appropriate, it can simply be ignored and the whole estate can be paid out to the survivor. If the trust is allowed to carry on as planned but later the survivor needs to raise capital, the trustees can pay out trust capital to the survivor although this may give rise to a tax charge.
The principle disadvantage of a discretionary trust is that a trust is a more complicated means of ownership than absolute ownership. Annual accounts will need to be drawn up and the trustees will have to do tax returns each year. For this reason we recommend that a solicitor should be one of the trustees; they will do all the work and make sure that the trust is managed properly from a technical point of view. The expense is normally more than compensated for by the gains made through the discipline of well planned and well managed investments.
In short, whenever inheritance tax is an issue the safe and conservative course of action is to include nil rate band discretionary trusts in your Wills because they provide a means for saving inheritance tax without actually committing you to the trust.
For more detailed information sheet about the taxation of discretionary trusts click here (NEED TEXT)
Link to information sheet on tax treatment of discretionary trusts (NEED TEXT)