PAM Guide to Wealth Management

Trusts

Trusts can play an important part in estate planning for substantial wealth, whether created in lifetime, or on death. They are an effective means of passing on wealth and can form part of an effective strategy for general estate planning, asset protection and tax mitigation, if structured carefully.

The UK inheritance tax treatment of trusts changed dramatically following the introduction of the Finance Act 2006. As a result, most lifetime trusts created on, or after 22 March 2006, together with certain trusts created before 22 March 2006, fall within the special regime of inheritance tax known as the relevant property regime.

In addition to inheritance tax, there are also other taxes to take into account in relation to trusts, including capital gains tax, income tax and stamp taxes (which are not considered in this chapter). The UK tax treatment of trusts created by individuals who are domiciled outside the UK is discussed elsewhere.

In general terms, inheritance tax applies in different ways, dependent on the category of trust, the two main categories of which are relevant property trusts and interest in possession trusts, subject to certain exceptions mainly relating to trusts for young children, as described below.

Trusts established on or after 22 March 2006 (during lifetime or on death), as well as trusts established before that date, which are not qualifying interest in possession trusts (see below), are taxed under the relevant property regime. Under this regime, an inheritance tax charge will arise on creation of the trust (to the extent that the value exceeds the settlor's available nil rate band), on every 10-year anniversary of the creation of the trust (the periodic charge), and on distributions from the trust to beneficiaries between 10-year anniversaries (the exit charge). There are complicated provisions for calculating the charges payable and careful accounting is usually required.

Qualifying interest in possession trusts, on the other hand, are taxed as though the trust assets belonged to the beneficiary with the interest in possession (the life tenant). Trusts which qualify for this treatment include immediate post-death interest trusts, which are created by Will or on intestacy, or disabled persons interest trusts; life interest trusts which existed prior to 22 March 2006 will be qualifying interest in possession trusts if there is a beneficiary with an interest in possession and that beneficiary has not changed since 22 March 2006, or if the beneficiary has a transitional serial interest (which will arise in limited circumstances). Instead of being subject to periodic and exit charges, the trust assets are instead subject to inheritance tax on the death of the life tenant.

Certain reliefs are available, including business and agricultural property relief, which can reduce or exclude charges to inheritance tax in some cases. Careful planning is required when seeking to rely on reliefs.

Trusts can still play a role in inheritance tax and succession planning. During lifetime, an individual can make lifetime gifts into a trust up to the value of their available nil rate band (£325,000 in 2015/16) (known as a nil rate band trust); provided the settlor survives for seven years from the date of the gift there are no immediate charges to inheritance tax.

Other lifetime planning may include settling on trust assets which qualify for inheritance tax exemptions or reliefs (such as business and agricultural property relief), or the use of loan trusts or discounted gift trusts, which can all form part of a package of lifetime planning which may be appropriate depending on your circumstances.

In all cases, there are important anti-avoidance provisions, which must be taken into account, including rules relating to gifts with reservation of benefit and pre-owned asset taxes. There are also other taxes which need to be borne in mind, plus non-tax considerations, so specific advice should always be taken before establishing trusts in this way.

It is also possible to create trusts in your Will, which come into effect on your death. One common reason for creating trusts in this way is to ensure that children do not inherit significant wealth at a very early age in the event of the early death of a parent, or to allow a surviving spouse, or civil partner, to enjoy the use of assets for the rest of their lifetimes, whilst ensuring that they pass to your children on the later death of your spouse, or civil partner. As noted above, there are certain trusts which can be created by Will, which fall outside the relevant property regime and which are therefore considered to be relatively inheritance tax efficient:

  • Immediate post death interest (IPDI): this trust is created by Will (or on an intestacy) and entitles the life tenant to receive the income of the trust fund during their lifetime; provided certain conditions are met (including the fact that the trust comes to an end on the death of the life tenant) the trust will be a qualifying interest in possession, and so it will fall outside the relevant property regime (thereby avoiding periodic and exit charges) and instead the trust fund will be treated as belonging to the life tenant for inheritance tax purposes.
  • Bereaved Minors Trust (BMT): A BMT is a trust for a child created on the death of one of the child's parents by their Will (or on intestacy, or as a result of compensation paid under the Criminal Injuries Compensation Scheme). The child does not become entitled to the capital until he or she turns 18. The advantage of the BMT is that there is no inheritance tax charge during the term of the trust, or when the child turns 18 (effectively escaping the periodic and exit charges which might otherwise be payable if the trust came within the relevant property regime), and no inheritance tax payable if the child dies before reaching the age of 18.
  • 18 to 25 Trust: Under the terms of an 18 to 25 Trust, the beneficiary (who must be a child of the settlor) must become entitled to the capital of the trust fund by the time they reach 25. Until the beneficiary reaches the age of 18 the trust fund is taxed in a similar way to a BMT. From the beneficiary's 18th birthday the trust fund will be taxed in the same way as a relevant property trust, but with a maximum charge of 4.2 percent arising when the beneficiary becomes entitled to capital.
  • Disabled person's interest: This is a specific type of trust established for someone who cannot manage his or her own affairs, because he or she is mentally disabled, or is receiving state allowances. Unlike IPDIs, BMTs and 18 to 25 Trusts, disabled person's interest trusts can be established during a settlor's lifetime, or in their Will and, provided the relevant conditions are met, will fall outside the relevant property regime.

As noted in the section above regarding Wills, one way of introducing flexibility into your Will is to incorporate discretionary trusts. A nil rate band discretionary trust is an efficient means of passing on a specific amount of value on trusts and can be useful, if you wish to make gifts to children, or others, on your death, without attracting inheritance tax on that amount.

A full discretionary trust of residue can also be tax efficient; the trustees are not confined to making outright distributions from the trust, but instead can apply income or capital to the benefit of beneficiaries, or transfer assets to different trusts if appropriate. Distributions made within two years of your death are effectively read back into the Will and are treated for inheritance tax purposes as if the gifts were made by you; this gives the flexibility to ensure that any action taken is the most efficient at the relevant time. It also gives scope for further planning after your death, depending on the circumstances of your surviving relatives.

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