The Benefits of Lifetime Trusts
The Benefits of a Trust
There are a number of positive benefits in having a trust, particularly as, the client can retain some influence over the use of the asset by being a trustee themselves or having a responsibility in appointing them. Equally, there are some persuasive arguments where trusts can be the perfect protection for assets:
- protecting against future bankruptcy of a beneficiary (a person who will ultimately benefit from the trust after the death of the settlor) or settlor (the person or people who set up the trust)
- protecting against potential claims following a matrimonial breakdown to which either the settlor or a beneficiary is a party
- protecting a potential beneficiary who is weak-minded against the possibility of undue influence
- preserving assets for the ultimate benefit of the children or grandchildren from a first marriage while ensuring that a second spouse or partner can continue to benefit from these assets during their lifetime
- mitigating nursing home fees
Types of trust
The settlor has a number of options if they decide that they wish to go the trust route, but in each case the tax implications must be considered carefully. The past and present trust arrangements are:
- discretionary trust
- an interest in possession (or life interest) trust
- a trust for disabled persons
- bare trust
This is a particularly helpful and flexible form of trust where the client is unsure of who they would wish to benefit and to what extent.
The basic format is that:
- the trustees can appoint the income and capital on further trusts in favour of a designated class of beneficiaries, and
- in the meantime, apply the income of the trust fund at their discretion for the maintenance, support, education or other benefit of the beneficiaries, with power to:
- apply capital for the benefit of the beneficiaries
- accumulate income
From a tax perspective, as long as the amount gifted does not exceed the settlor’s nil rate band allowance (£325,000 for a single person, £650,000 for a married couple), there will be no inheritance tax implications. Above that limit there will be a lifetime tax charge of 20% on the difference together with a 6% charge on every 10th anniversary subject to reliefs such as for agricultural or business property.
Interest in possession
Such a trust will typically provide for beneficiaries to receive trust income, generally for life or other fixed time limit. Sometimes provision is also made to advance capital.
In order for this form of trust to be effective, the beneficiary must have an immediate right to the income. In other words, the trustees do not need to meet and make a decision whether or not to make a payment.
Regarding inheritance tax (IHT), any such trusts created after 22 March 2006 will be treated in a similar manner as discretionary trusts (ie as ‘relevant property trusts’). There will be an immediate charge of 20% on the sum exceeding the nil rate band, and if the settlor dies within seven years, a further charge of 20% will be incurred. The same 6% 10-year anniversary charge will also be payable, along with exit charges when the beneficiary becomes entitled to capital.
Elderly clients with disabled children/grandchildren/nephews/nieces, etc, have an especially challenging problem, particularly as a mentally disabled person cannot themselves give a proper receipt for a gift. You will want the relative to be well provided for but they will not wish to disturb that person’s entitlement to means-tested welfare benefits. The answer in such circumstances is inevitably either a straightforward discretionary trust, or more effectively, a disabled trust.
A disabled trust is a pure statutory invention and, because of this, in order for it to be effective it must satisfy the appropriate statutory requirements, namely that the disabled person is:
- incapable by reason of mental disorder of administering their affairs, or
- in receipt of attendance allowance or disability living allowance by virtue of entitlement to the care component at the highest or middle rate
- in receipt of personal independence payment by virtue of entitlement to the daily living component
The practical effect is that, if the statutory requirements are met, the disabled person will be deemed to have an interest in possession of the trust property that will not be within the discretionary trust charging regime. Because of this, any addition to the trust by third parties will be treated as a potentially exempt transfer. A charge to inheritance tax could arise on the death of the disabled person as that person, with a deemed interest in possession, will have their interest amalgamated with their own personal assets.
In effect there are two forms of disabled trust, namely:
- discretionary—where no interest in possession exists and where the disabled person is a potential beneficiary
- life interest—where the disabled person has an actual interest in possession
If you have a imprudent child or grandchild (perhaps by reason of drink or drug abuse, or simply because they are spendthrift) and wish to see them provided for but not have free rein with a large (or any) inheritance, a protective trust is a solution. With a life interest trust, although the beneficiary has an interest in the income they have no ability to use the capital. While the capital is protected from creditors, etc, the income is not. A protective trust is one where the income is paid for life, or until bankruptcy or assignment of the income or where the life interest is otherwise disposed of or charged in such circumstances that the income interest then passes to another person.
Town & Country Law are able to offer Clients clear advice, tailored to their specific situation in relation to any of the above Trusts.
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Call us on 01522 282500.