What is a trust?
A trust is a legal arrangement where one or more trustees are made legally responsible for assets. The assets – such as land, money, buildings, shares or even antiques – are placed in trust for the benefit of one or more beneficiaries.
Trustees are responsible for managing the trust and carrying out the wishes of the person who has put the assets into trust (the settlor). The settlor’s wishes for the trust can be given in a legal document called the trust deed, however, they are usually incorporated in their Will to safeguard assets.
Trusts are set up for a number of reasons; to control and protect family assets, when someone is too young to handle their affairs, when someone can’t handle their affairs because they are incapacitated, to pass on money or property while you are still alive, to pass on money or assets when you die under the terms of your Will – known as a Will trust.
There are many different types of trusts.
What is a discretionary trust?
A discretionary trust is a legal device created by the person putting funds into it to benefit one or more people named as potential beneficiaries.
Like all trusts, a discretionary trust is run by trustees. In this instance, however, the trustees are responsible for making the decisions about how the trust is run and how the beneficiaries of the trust are dealt with.
The important feature of this type of trust is that trustees have discretion as to how the income and capital is distributed amongst the beneficiaries.
What can a trustee decide?
Trustees can determine and control various aspects of the trust including:
How much of the trust is paid out to individual beneficiaries
Which beneficiaries receive payments and when
How often payments to beneficiaries are made
What conditions are imposed on beneficiaries
The extent of a trustee’s discretion depends on the conditions laid out by the trust’s creator.
What kind of specifications can be made?
The person who sets up the trust can specify when capital from the trust can or should be used. They may, for example, make a provision for extra capital to be used for any grandchild’s higher education costs. If a beneficiary is incapable of dealing with money by themselves, it can be suggested that the trustees oversee any financial arrangements made on behalf of that beneficiary. This is often the case if the beneficiary is mentally or physically disabled or is a child below the age of 18. These types of discretionary trusts may qualify for tax exemptions.
The trustees of a discretionary trust are responsible for dealing with all issues concerning taxation, including income tax. Tax due on the income of the trust is paid each year as part of an annual trust and estate tax return. Income is taxed at special rates, excluding the first £1,000 or standard rate band. If there is more than one trust, the standard rate band is divided between the trusts. For trusts whose primary beneficiary is someone considered to be a vulnerable beneficiary, special rates of tax are applied.
Capital gains tax
Capital gains tax is payable on the profits of any sale or transfer of assets including property, shares or possessions. Each year, an amount known as the annual exempt amount allows trustees to transfer or sell assets with a certain amount of value before capital gains tax is payable. Any amount over that exemption rate is liable to capital gains tax, which is paid by the trustees.
Inheritance tax is currently levied at 6% every ten years on the taxable amount above the nil rate rand.
Payments to beneficiaries
If a beneficiary receives a discretionary payment from a trust, it is subject to a tax credit at 40 per cent. If the beneficiary is a non-taxpayer or pays only the basic rate of tax, they can then claim some or all of that tax back. A tax pool allows trustees to ensure that the correct amount of tax has been paid on all discretionary payments made from the trust.
Discretionary trusts are an ideal way to distribute the assets of an estate fairly between multiple beneficiaries who may have different requirements at different times, but because of the complex tax implications involved, it is best to talk to an expert if you wish to set up a discretionary trust for your beneficiaries.
One common use is when children are in difficult circumstances e.g. business is in severe financial difficulties, addictions or going through divorce. All circumstances would benefit from a flexible approach to how children might inherit.
Protective property trust
A protective property trust allows an owner or co-owner to safeguard their share of the house for their children or other relatives in the event of their surviving spouse remarrying, having further children or requiring long-term care. To prevent the surviving spouse being forced to sell the house, the gift to the children can be delayed until the surviving spouse has died.
People cannot be forced to sell their home to pay for the care fees of their partner if it is placed in a trust.
If one partner dies and the surviving partner needs to go into care, all their assets and property will be assessed by the local authority. If your assets are valued over £23,500 then you may be forced to sell your assets to pay for care fees.
To avoid this situation, you can draw up a Will which incorporates a property trust. Within this Will, each partner leaves their half of the house in trust for the children or other nominated beneficiary. That half cannot be claimed, however, until the surviving partner dies.
Although the surviving partner would have full use of the trust half of the property, he or she would not own it and the local authority could not claim it for care cost fees. Obviously as a widow or widower you would need to make a settlement of your property to your trustees.
Life interest trust
A life interest trust is similar to the protective property trust, in that property can pass to an individual for them to benefit from for the rest of their life, and then upon their death, for the capital to pass to someone else.
For example, Graham would like his sister to receive the income from his investments, but be guaranteed that the capital will pass to his cousin when she dies. By giving her a life interest in his investments his sister would not be the legal owner of the property so couldn’t sell or give his investments away to anybody else and will be able to live in the property for her lifetime.
Disabled beneficiary trust
In leaving a gift to a disabled beneficiary, problems may arise which outweigh the benefits, i.e. 1) the assets of the beneficiary could be increased to a level which affect the eligibility of receiving means tested benefits; and 2) if the beneficiary has learning difficulties the Office of the Public Guardian could apply to have an Official Receiver appointed for the beneficiary in order to administer the gift on their behalf, which would incur charges.
Alternatively, if no provision is made for a disabled dependant, then the Office of the Public Guardian could contest the will to obtain a share of the estate on behalf of that dependant. In view of the above, it may be better to leave a gift to a trust so that the trustees can make periodic payments to the disabled beneficiary. This will ensure that state benefits remain unaffected and avoid the other problems.
Business assets discretionary trust
Business owners can claim some valuable exemptions from inheritance tax, but if a beneficiary later sells their share of the business, the cash proceeds would potentially be subject to IHT at 40 per cent when they die. By incorporating a business assets discretionary trust in a Will, the trustees can lend the business assets to a spouse or other beneficiary so that the valuable tax relief is maintained.
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