Do trusts still serve a purpose?

  • Describe some of the advantages and disadvantages of trusts
  • Describe how family income companies work
  • Identify the advantages of a flexible family trust
Do trusts still serve a purpose?

HMRC Trust statistics continue to show a decline in the number of existing trusts and new ones being formed.

This is unsurprising given the impact of the 2006 tax changes.

While trusts may have fallen out of favour, should they be consigned to history just yet?

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The old regime and the 2006 changes

Until 2006, it was possible for families to create certain trusts to pass wealth down generations without upfront inheritance tax (IHT) charges.

Known as ‘accumulation and maintenance trusts’, provided beneficiaries took certain benefits by age 25, in addition to no upfront IHT charges, these trusts benefited from a simple tax regime that did not impose ongoing 10 yearly tax charges.

Such trusts were often used to safeguard wealth for minors, with income being controlled by trustees, but flowing directly to beneficiaries once capable of handling their own finances.

This changed in 2006, with the majority of new trusts being subject to the ‘relevant property regime’.

This regime imposes a 20 per cent entry charge on additions to a trust in excess of a person’s tax free nil rate band of £325,000, and also means the trustees become liable to 10 yearly tax charges on the value of the trust fund and when funds exit the trust.

For many, these changes were too much to bear and trusts fell out of favour.

The alternative?

Family investment companies (FICs) have become a popular choice, largely due to the absence of an entry charge and the lack of ongoing IHT charges under the relevant property regime.

The other attraction is that clients tend to be familiar with limited companies as many entrepreneurs trade through that medium already.

With suitable guidance, a company can echo many of the hallmarks of a traditional trust; directors stand in the shoes of trustees and shareholders as the beneficiaries, allowing directors to manage the company assets on the shareholders’ behalf.

Furthermore, with suitable articles of association (the company rulebook) and a well-drafted shareholders' agreement, directors can control the payments made to shareholders.

In addition to no upfront entry charges, due to the differing tax rate (FIC 19 per cent, Discretionary Trust 45 per cent), a FIC can enable wealth to be rolled up and the compounding effect of the different tax rates over time can be dramatic.

In most circumstances dividends received by a FIC are not taxed.

Will this regime continue if we have a change of government?

A large part of the attraction to FICs is its ongoing tax efficiency due to the lower rate of tax on income and no tax on dividends.

The current tax rate (19 per cent), which is due to reduce in April 2020 to 17 per cent, has not always been this low.

In 2010, the main rate was 28 per cent, so the current low rates may not last.

With the prospect of an imminent General Election, it is worth considering what impact a change of government might have.