Trusts: What you need to know

When should a client think about setting up a trust, how expensive and time consuming is it, and when is it worth the effort?

“Generally, trusts mean people can give money away to help reduce the value of their estate and therefore IHT that may be due,” says Laura Suter, personal finance analyst at AJ Bell.

Because the rules around trusts can be very complicated, it is an area where seeking professional advice will pay off Laura Suter

She explains: “Trusts are often seen as something only for the super-rich, but they can actually be used for more everyday finances, such as helping towards the cost of university for a grandchild or to hold life insurance payouts on death.

“Because the rules around trusts can be very complicated, it is an area where seeking professional advice will pay off.”

She adds: “There are of course costs associated with doing so, and setting up and maintaining trusts, and the more complex the structure the higher these costs are likely to be, so you need to balance the value of the estate with the potential tax saving from opening a trust.”

Fear of complexity

According to Tracy Crookes, financial planner at Quilter Private Client Advisers, trusts often cause apprehension, or the “fear is that they are too complicated and too expensive, but this isn’t always the case”.

 There are occasions where a complicated trust is needed Tracy Crookes, Quilter Private Client Advisers

Ms Crookes says: “Yes, there are occasions where a complicated trust is needed. This is dependent on personal circumstances and intentions but, in many instances, platforms and providers have standard trust solutions that meet customer needs and these can be obtained with appropriate advice.”

Philip Whitcomb, partner and head of rural private clients at Moore Blatch, says: “In recent years, trusts have received bad press but they are still highly useful, particularly when considering asset protection. 

“If you have concerns about the financial security of the intended beneficiaries or they may go bankrupt or, quite often, there are concerns about the daughter-in-law or son-in-law, then a trust can assist in protecting the capital for your family.”

He suggests that, as families are becoming more complex, with second marriages for example, trusts can be used to ensure assets are passed to children.

Key points

• Trusts can be used to protect a client’s estate.
• They do not have to be too complicated.
• Using a trust can be expensive but worthwhile.

According to Mr Whitcomb, the most common mechanism is a life interest trust.

“This allows a second spouse to enjoy an income from the assets or the right to live in the property during his or her lifetime but, after their death, then the assets revert to your blood children rather than perhaps to the spouse’s own children,” he explains.

He adds: “If [your clients] can give up capital, consider a discounted gift trust. 

“These are designed for people who want to give money to a trust but still retain the ability to draw down a regular income – up to 5 per cent – for the rest of their lives.” 

Setting up the right trust

As a range of trusts could potentially be useful for inheritance tax planning, advisers will need to select the right one for the client.

Advisers will also have to make sure the trust is set up properly if it is going to be effective and will also need to be aware of not only the benefits but also the drawbacks, restrictions and possible charges, suggests Patrick Connolly, chartered financial planner at Chase de Vere.

He explains: “A trust is a legal arrangement where one or more trustees are legally responsible for holding assets for the benefit of one or more beneficiaries. 

“The creation of a trust is a transfer of value for inheritance tax purposes, which means that tax could potentially be payable when the trust is set up, particularly if larger sums are moved into a trust.”

The person creating the trust will appoint the initial trustees. 

He continues: “A trustee can be any adult who has full mental capacity. 

“However, you’ll need to make sure they are willing to be a trustee and that you are confident they can perform the required duties.”

He adds: “It is common for the settlor to be a trustee, which means they can have a degree of control over the trust assets.”

However, he suggests it is important to be careful to ensure that the settlor is not a potential beneficiary, because with some trusts, HM Revenue & Customs could regard this as a reservation of benefit so it will not be effective for inheritance tax purposes.

He adds: “A beneficiary can also be a trustee. Where trustees have discretionary powers, it is advisable to have at least one independent trustee who can’t benefit from the trust.”

How are trusts tax effective?

Trusts have been used for many centuries as a way of passing on wealth, according to Gill Philpott, tax and trust specialist at Ascot Lloyd.

She says: “While direct gifting is available, this may not be a preferred route, particularly if the beneficiary is young, there is concern over their relationship or financial status, or if the next generation already has taxable estates and different financial needs. 

“The use of a trust will allow assets to be protected and their future destination managed in a tax-efficient manner over the next 125 years if desired – the current time over which a trust can be set up for – helping with generational tax planning over the longer term.”

She adds: “The flexibility of trusts means there are trusts to suit almost all circumstances.” 

She warns, however, that the rules around IHT and gifting will need to be considered. 

“While as a rule it is not tax-efficient to gift an asset away and retain some benefit, this can be possible with the right trust,” she says. 

“This helps to deal with the dilemma of reducing an estate for IHT by making a gift but being able to retain accessto regular payments or capital sums.”

She continues: “While the initial gift to a trust has the potential to be subject to IHT, this can be managed; gifts below the IHT nil rate band will not suffer lifetime tax. 

“The trust will be subject to its own IHT regime, with an IHT event every 10 years and potentially when assets leave the trust. 

“But the IHT payable will not be more than 6 per cent of the asset value held by the trustees and, in the vast majority of cases, will be at a lower rate and a potential 0 per cent.” 

This means that trusts can be tax effective and, while there are likely to be costs in setting up a trust arrangement, “spending a couple of thousand pounds to protect many more thousands in assets should not be cost-prohibitive’,’ says Ms Philpott.

“There are potentially ongoing tax and regulatory requirements to be met after setting up a trust but the administrative time and cost will be small in comparison to the potential IHT saving.”

Victoria Ticha is a features writer at Financial Adviser and FTAdviser.com