The establishment of a trust involves three parties:
- The settlor – the person giving assets to the trust.
- The beneficiary (or beneficiaries) – those who will benefit from the trust.
- The trustees – those who will manage the trust on behalf of the beneficiaries.
There are many different types of trust, but here we’ll focus on the myth that surrounds the use of trusts in estate planning (as opposed to those involved in investment or pension trusts).
It’s certainly true that trusts are often used to mitigate IHT. The nil rate band for IHT has been frozen at £325,000 since 2009. If a person gifts this amount, into a trust or directly, after seven years this falls outside their estate for IHT purposes.
The annual exemption of £3,000 and the small gift allowance of £250 have been frozen since 1984.
But where IHT is a concern, families may need reminding that it is all too easy to put the tax tail in front of the investment dog. Mitigating IHT is the means to an end – it’s the passing down of family assets – rather than the end itself.
Families need to have an open and honest discussion with their advisers about what it is they really wish to achieve. Financial planning is much more effective when objectives are clear.
If a person wishes to pass on assets to younger generations, a trust can help them do so and it can be an appropriate vehicle to do so tax-efficiently.
Remember as well that trusts exist so assets can be managed by party on behalf of another. There are many situations where assistance may be sought to manage assets this way. Perhaps the beneficiary or beneficiaries are too young, or for other reasons lack the capability to manage the assets. Perhaps the settlor does not want the beneficiary to receive too much in one go and would rather inheritance is received over time in a more controlled manner.
A scenario we see frequently is a trust being used following a second marriage to secure inheritance for children of a first marriage that could otherwise find them disinherited.
Many families are way more complicated than the 2.4 children stereotype, and the legal formality of a trust provides greater certainty of distribution in accordance with the wishes of the settlor. Holding assets in trust can also be a means to protect family wealth from risk of divorce or bankruptcy.
Families considering setting up a trust need financial advice. A trust needs to be set up carefully and correctly, with a full understanding of how it will work today and for future generations. Trusts can, and certainly are, used by many families to help mitigate IHT, but this is only one aspect of their application.
There are many types of trust, and different types of trust are subject to different tax rules which are beyond the scope of this blog. An understanding of the principles of trust should be an essential part of every financial adviser’s knowledge, even if they are not a trust specialist.
It remains the case that trusts are sound, legal structures – and though rooted in centuries of history – can be used effectively to help families achieve a wide variety of financial planning goals, protecting and preserving wealth intergenerationally.
Adapted from an Article in the FT Advisor by Mark Wintle from April 27, 2021