Using trusts to support tax planning, and to manage complex family dynamics when considering succession

What are the tax benefits of using trusts?

The tax benefits of using trusts are well documented, but to recap just briefly:

• Assets placed in most modern trusts sit outside the estates of the beneficiaries, and as long as the settlor survives the gift into trust by at least seven years, the assets may escape the threat of a 40% IHT for multiple generations. Depending on the value, the maximum IHT payable will instead be just 6% ever 10 years – a prospect that is often more palatable, especially because of its predictability.
• Most trusts also benefit from their own Nil Rate Band (NRB), providing up to £325,000 IHT free, which, again, provided that the settlor survives the gift by seven years, give an IHT saving of £130,000. The NRB refreshes every seven years, and so a settlor can set up multiple trusts over the course of their life, each time taking another £325,000 out of the 40% tax net, if they wish. Care needs to be taken when multiple trusts are settled by the same settlor within 7 years of each other, when the NRB may not be available upon settlement, or when calculating 10-year charges.
• Capital Gains can usually be held over on assets settled into trust, deferring CGT and avoiding a dry tax charge. Hold over relief can also apply when taking assets back out of the trust, although in both cases there are a few restrictions, for example when considering settlor interested trusts (which are generally not useful for tax planning) and properties used as the main residence.

But the other, non-tax benefits are perhaps less well advertised, but are arguably more important on a practical level, providing families with certainty, control and security over their hard-earned wealth.

Example: When a trust gives certainty

Let us take the example of a married couple, Dave and Annie, in their 40s with two young children.  They jointly own the family home (ideally as tenants in common) and some modest investments.

If they have traditional mirror Wills where all the assets are left to the survivor on the first death and to the children on the second, this could have unintended consequences, if for example something happens to Annie and at some point in future, Dave remarries.

Under this scenario, when Dave gets married, his original Will becomes defunct. If a new Will is not then drafted, then his new spouse could be in line to inherit a large portion of his assets if they go on to outlive Dave, which could reduce what the children inherit.  Even if a Will is put in place, there is no guarantee that Dave and Annie’s children would inherit what their mother intended for them, especially if Dave has gone on to have more children, for example.

Life Interest Trusts are a very effective way of providing certainty and protecting the children of a first marriage where one parent passes away and the other remarries.

If Annie had included one of these in her Will, Dave would have only a life interest over the property (and the proceeds of a sale of this) and on his death, the asset (or the reinvested proceeds) would pass on to Annie’s children, irrespective of any Will Dave now has. He would have all of the benefits of the house and investments during his lifetime, but Annie would have certainty that her children would still one day benefit.

These sorts of Trusts can work equally well for blended families, giving a surviving (second) spouse the right to use a property during their lifetime, but ensuring that the children of a first marriage inherit ultimately.

Better still, where a Life Interest is created for a surviving spouse, the normal spousal IHT exemption applies so that IHT does not become payable until the second death, or, potentially not at all if the surviving spouse decides to end their interest in the trust early and survives at least 7 year from doing that. These sorts of trust also avoid 10-year charges during the lifetime of the first beneficiary and can be structured ether to end when the survivor dies, or to continue into a further trust to maintain long term planning and protection options.

Example: When a trust gives control

In our second example, Vince wishes to pass on his shares in the family trading business to his son Andy.  Andy Is a bit flighty and currently has an unsuitable boyfriend, who Vince would rather keep away from the business. Vince does not necessarily trust Andy to hold the shares outright or make decisions about the future of the business without being influenced by his partner. Even so, Vince wants Andy to have access the income the business produces now and not just in future, and he is also concerned about the changes to Business Property Relief, so he wants to act now.

Rather than give his shares to Andy outright, he could consider settling these into a Discretionary Trust for Andy (and potentially other)’s benefit.  Whilst Vince remains the Trustee (during his lifetime) he can continue to control the shareholder votes of the shares held by the Trust, safe in the knowledge that Andy can benefit from the income…. But only if and when Vince decides to give it to him! Vince has complete discretion and can maintain control, as long as he does not retain any benefit of the shares, if he wants this to work from a tax perspective too.

From an IHT perspective, if done before the changes to BPR, it should be possible to minimise the tax on settlement, and as long as he survives the gift by 7 years, the shares will sit outside Vince’s estate. The trust will suffer a charge to tax every 10 years, but whilst the shares qualify for BPR, it will be at a maximum of 3%.

Example: When a trust gives protection

In our final example, Siobhan has two daughters – Keren and Sara. Keren is happily married but Sara is a few years younger and had not settled down yet.

Siobhan has a valuable family business but is planning on selling this so she can retire, and she wants to help both her daughters onto the property ladder with the proceeds. However, she is not overly keen on Keren’s husband, if truth be told, and she has no idea what Sara might do.

Just before selling her shares in her business, she could consider settling a portion of these into trust (to make the most of BPR whilst she still can).  Once the business is sold, the Trust simply holds cash.

Keren wants to move to a bigger home so takes a loan from the trust (avoiding an exit charge and maintaining the value of the trust) to do that. Six months later her husband files for a divorce.  However, the money provided by the trust is just a loan and cannot be taken into account when calculating the couple’s joint wealth, so thankfully, Keren has some level of protection as a result of the trust.  Meanwhile, Sara has developed an unhealthy relationship with Pinot Noir. Because of the trust, Siobhan is in a position to decide to leave Sara’s share of the money in the trust until she sobers up….the gift has still been made from an IHT perspective, so the 7 year clock has started, but there is no need for Sara to have access to the funds until she can be trusted to buy something other than Burgundy.

Why use trusts?

In all three scenarios, even before considering the potential tax benefits, the trust serves as a way to protect those who the funds are designed to benefit, even if just from themselves.  No one knows what the future holds and with ever changing family relationships, a trust can be a practical solution to provide peace of mind for those giving away their wealth.