Inheritance Tax  

How to pick the right trust

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Death, tax and demographics

How to pick the right trust

Trusts first appeared in English law during the 11th and 12th centuries to protect the rights of landowners who travelled to fight in the Crusades. The Court of Chancery established the principle that the ‘benefit’ of a property did not always belong to the person who held the title deeds. This point remains the cornerstone of trust law.

Another common use of trusts emerged in the 15th and 16th centuries, when death duties were avoided by transferring property into common ownership.

A trust is an arrangement under which the owner of an asset and the beneficiary are not necessarily the same. The parties involved in trusts are:

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1 The settlor: the person who “settles” property or assets into trust. 

2 The trustee: the person who manages the trust property for the beneficiaries. 

3 The beneficiary: the person who benefits from the trust property. English law requires that all trusts, apart from charitable trusts, have at least one beneficiary.

In many trusts, it is possible for the same person to hold multiple roles. Legally, these roles are treated as separate. For example, a settlor might also be a trustee and a trustee might also be a beneficiary.

It is unusual, however, for a settlor to be a beneficiary, because they may fall foul of gift with reservation rules that govern lifetime gifts.The main purpose of many, but not all, trusts is to remove property from a settlor’s estate. If the settlor survives for seven years following the date of the settlement, the property will fall outside his or her estate for the purposes of IHT (see table: Seven-year rule).

Trusts can also be set up after death through a will or through the laws of intestacy (in which case the bequeathed assets will be subject to IHT).

Since a change to the IHT regime on 22 March 2006, most trusts can be categorised as either relevant property (RPR) trusts or non-RPR trusts. The most common RPR trust is a discretionary trust; the most common non‑RPR trust is an absolute (also known as a bare) trust. 

The ways these trusts mitigate IHT vary. As a rule, the more flexibility or control the settlor wants, the less IHT‑efficient they become.

Discretionary trusts

Discretionary trusts grant the trustees discretion over the identity of beneficiaries. The trust document may list beneficiaries, or classes of beneficiary, but ultimately the trustees can choose to whom they distribute income or capital. 

This discretion can be particularly useful if, say, beneficiaries have lifestyle problems that mean it may not be appropriate for them to receive a large sum at a certain time. Similarly, trusts can help protect assets when beneficiaries are going through bankruptcy or divorce proceedings: since the trustees have discretion over whom to pay benefits, the courts cannot usually order that they are paid to other parties. 

However, this flexibility comes at a price. Transfers of assets into trust are classed as chargeable lifetime transfers (CLTs), which means the value of assets above the nil-rate band (NRB), currently £325,000, will be subject to a tax charge of 20 per cent. This is ‘grossed up’ to a higher figure (usually 25 per cent) if the settlor pays it. If the settlor dies within seven years, a further charge of up to 20 per cent may be incurred.