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A guide to Estate Protection:Trusts

PENSIONS & INVESTMENTS WILLS & TRUSTS LIFETIME CASH FLOW PLANNING

Wealth & tax management


FEBRUARY 2011

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What is a Trust?
A trust is a legal instrument which originates from the Middle Ages, when knights about to join the Crusades in the Middle East would transfer their possessions and land to the safekeeping of a trustee while they were away. The trustee would be given legal title to the knights land and possessions and would be given full responsibility to manage them in his absence, provided that any decisions they took were for the knights (the settlors) benefit rather than their own. A person who creates a trust during his lifetime is known at the settlor. Trustees have the responsibility of managing the trust on behalf of the settlor and the beneficiaries, much like a board of directors has the duty of running a company on behalf of its shareholders. The beneficiaries are the people who will benefit from the trust by receiving income or capital from it. The trustees and beneficiaries are all named in the trust deed or in the Will if the trust has been created by a Will trust on the death of the testator/testatrix i.e. the person who set up the Will trust. In modern times, the range and use of trusts has become more sophisticated but the principle remains the same. Trustees are now commonly companies set up specifically for the purpose and the beneficiary of a trust can be anybody the settlor chooses, very often family members or charities. The trustee will be the legal owner of any assets transferred to the trust and must look after those assets according to the terms of the trust deed drawn up at the outset as determined by the settlor or a deceased settlors will.

Why use a Trust?


A very common use for trusts is to ensure that children who are left or given large sums of money do not have full access to it before they are mature enough to use it wisely. Trusts can also be set up to ensure that the donor retains more say in how their assets can be used after their death or to prevent a family business from becoming fragmented if its legal ownership is split between too many beneficiaries. Almost any type of assets property, bank deposits, shares etc can be held in a trust. Trusts can also be used for tax planning purposes, for asset protection (by distancing assets from their owner in the event of divorce or company failure for example) and for those seeking some privacy for their families when they die the contents of most Wills are on public record at the Probate Registry but the contents of a trust are not. A further interesting point about trusts is that they cannot usually be legally challenged after death whereas Wills can be challenged and completely re-written. They can be challenged particularly by financial dependants who have been left out of the Will. Equally, beneficiaries may decide to simply vary the Will which they are entitled to do within 2 years of death by deed of variation.

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Types of Trust
Bare Trust
A Bare Trust is the same thing as a "simple Trust." It is one where the beneficiary gains immediate, absolute right to the assets in the Trust and the income generated. A settlor (the person placing funds into trust) creating a Bare Trust is certain that the assets in the Trust go directly to the beneficiary or beneficiaries they choose. Once this Trust has been set up the beneficiaries cannot be changed.

Discretionary and AccumulationTrusts


A Discretionary trust lets Trustees have discretion about how the Trust's income is used. In a Discretionary Trust, the Trustees are legal owners of the assets in the Trust. They must run the Trust to benefit the beneficiaries. In accumulation Trusts, Trustees can accumulate the Trust's income until the beneficiary is legally entitled to the property or the income generated by the Trust.

Interest in Possession Trust


An Interest in Possession Trust entitles the beneficiary to the Trust income as it is generated. The Trustee must pass all income received (minus Trustee expenses) to the beneficiary. If the beneficiary is entitled to the income for the duration of his or her life, he or she is known as a "Life tenant."

Offshore Trusts
Offshore Trusts are run by Trustees who are not UK residents for tax purposes. The tax rules for Offshore Trusts are quite complex. In some Offshore Trusts, only some of the Trustees are UK residents, and the settlor of the Trust was not a UK resident when the Trust was set up or when assets were added to it.

Employee benefit trusts


An employee benefit trust is in broad terms a discretionary trust for the benefit of employees. The employees and ex-employess will be the beneficiaries of the EBT and the trustees will usually be a professional trustee company or the directors of the company. EBTs are a particularly useful store for private company shares whether they be to create a marketplace for the shares, to enable the owners to exit from the company or simply to incentivise employees.

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An EBT is subject to Income Tax and Capital Gains Tax. There are tax reliefs from Capital Gains Tax and Inheritance Tax in respect of certain gifts of shares or sales of shares at an under-value into an EBT. An EBT does have favourable Inheritance Tax status in that it does not suffer from the 10 yearly periodic charge to Inheritance Tax unlike most other trusts.

Pension trusts
All employer pension schemes are written into trust. This follows the Maxwell scandal of the early 1990s. Many private pension schemes are held in the Master Trust of the pension provider. Usually the pension scheme member will complete a deed of nomination confirming the details of the beneficiaries and how much to leave to each of them. Private pensions may also be written into trust by using the pension providers own trust or a private family trust. In the following example you have a widowed mother who receives the death benefits from her late husbands pension and then remarries. Were she to subsequently divorce 50% of the money could go to her ex-husband instead of to her children. This can be avoided by putting the pension into trust and making the wife and their children the beneficiaries of his estate. Money can then be lent to the widow and/or the children by the trust thus ring fencing it from the new husband.

Pension

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There are many other types of trusts such as Charitable Trusts, Mixed Trusts, Parental Trusts for Minors, Settlor-Interested Trusts and Vulnerable Beneficiaries Trusts. These trusts usually have different purposes and may have different tax treatment.

Trust & Wealth Management


A major reason why trusts are still used today is to give social impact protection to the beneficiaries and to ensure that the inheritance passes down the bloodline. By transferring assets into trust the settlor is able to protect beneficiaries against the financial burden of the following social impacts; I I I I Death Divorce Bankruptcy Nursing home fees

The settlor is also able to ensure that his inheritance passes down the bloodline to his children, grandchildren and great grandchildren. The technique of trustees lending money to beneficiaries rather than gifting it is very powerful. This is because the money never forms part of the beneficiarys estate, it is protected against social impacts and the amount borrowed from the trust, instead of creating an inherited Inheritance Tax liability, in fact produces a debt on the beneficiarys estate which saves Inheritance Tax!

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Deceased

Deceased

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Will

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BPT

Beneficiary

Seperation

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Ring Fence

The above example gives a before and after trust planning example. In the left hand diagram you can see that the deceaseds inheritance is not protected as the beneficiaries could potentially have their inheritance eroded by various social impacts. Furthermore, they have inherited an Inheritance Tax liability. The example in the right hand diagram shows the benefit of a trust ringfencing the inheritance against these social impact threats. A further benefit is the saving in Inheritance Tax especially as any money advanced to the beneficiaries is likely to be in the form of a loan rather than a gift which reduces, rather than increases, the beneficiaries estates for Inheritance Tax purposes. Typically a married couple with, say, 2 children would set up a trust

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rge a Ch n a Lo

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IHT FREE after 7 years 3. Additional NRB

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Trust

The above example is a more sophisticated approach which involves setting up, say, two trusts for the children and one for the surviving wife. The husband dies. Assets from his estate pass into a trust which then lends money to the widow. His Nil Rate Band of 325,000 for Inheritance Tax relief is used in full on his death. His widow then gifts the money lent to her from the trust to the children up to 325,000. Then in 7 years time she becomes entitled to a further 325,000 Nil Rate Band allowance. Private family-controlled trusts are extremely effective instruments for managing wealth and protecting it over the generations. Trusts have been used increasingly for Inheritance Tax mitigation over recent years and as a result the government has increased the burden of taxation on trusts. However, there remain tax planning opportunities to be exploited by skilful planning.

1. Set NRB 2. Carry forward NRB

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An example of this is the offshore investment bond written into trust. An investment bond, or single premium non-qualifying whole of life insurance policy to give it its technical name, has a number of distinct advantages over other forms of investment, particularly when used as a trust investment. Firstly, the profit, or chargeable gain, on a full or partial surrender (sale) of an investment bond is only ever subject to Income Tax and no other personal taxes. Partial encashments of up to 5% per annum, cumulative, of the original sum invested may be taken without triggering any further immediate Income Tax charges. It must be emphasised that these are not tax free withdrawals but tax deferred ones. Chargeable gains on onshore bonds are deemed to have had basic rate Income Tax deducted at source whereas offshore bonds are deemed to have suffered zero Income Tax at source. There is a complicated formula for calculating how much tax is due, if any, on a chargeable gain. In the case of the onshore bond the rate of Income Tax can only ever be the difference between the basic rate and the higher rate i.e. 20% (40-20%) unless you are a higher earner paying 50% Income Tax in which case the rate will be 30% (50%-20%). Offshore bonds, on the other hand, are deemed to have suffered no Income Tax at source therefore the chargeable gain is taxed at the owners top rate of Income Tax in full i.e. 40% or 50%. The principal advantage of investment bonds as trust investments is the fact that the trust can defer paying Income Tax for many years, in fact over several generations even, especially if an offshore bond is used. Tax deferred is tax saved after all. Furthermore, when the offshore bond starts to be encashed to pay benefits to children, for example, then taxation can be reduced to basic rate or even zero Income Tax by assigning (gifting) segments to them. This can be particularly useful for University fees planning for children or grandchildren.

1 The Willows Mill Farm Courtyard Stratford Road, Beachampton Milton Keynes MK19 6DS T: 01908 260418 F: 01908 260415 Email: wealth@wealthandtax.co.uk www.wealthandtax.co.uk

Wealth & tax management


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