Family trusts – what are they and should I consider using one?
A trust provides families with the opportunity to make generational transfers of wealth, while preserving a degree of control and asset protection. When used in conjunction with assets that qualify for certain inheritance tax reliefs, they can be tax efficient and need not be associated with the complexity that many fear.
In this article, we discuss trusts more widely, before focusing on when a 'family trust' may be appropriate for a family's succession planning.
Tax is just one factor as to when and why a trust may be used, and often is not a primary consideration. However, inheritance tax is quite a 'hot topic' politically. With IHT receipts forecast to rise to 1% of the total tax take in the coming years, the attention seems disproportionate. Still, its complexity and status in the national psyche mean it is likely to continue to be an area of ideological focus.
What is a trust?
A trust is an agreement entered into:
- By an individual or individuals - the settlor(s).
- For assets to be held and managed by trusted people – trustees.
- For the benefit of other individuals – beneficiaries.
A trust is established by way of a formal document (deed), or by a Will, which summarises who the parties are, what assets are held 'in trust', and what the terms of the trust are.
What kinds of trust are there?
There are several different types of trust and each has its own advantages and restrictions. Most can be set up either during a person's lifetime or on death, with some exceptions:
- A discretionary trust – where trustees have full discretion as to how trust assets are managed and passed to beneficiaries.
- A life interest trust – which provides for trust assets or income to be available to an individual for the remainder of their life, or a fixed period.
- A bare trust – which is a simpler nominee arrangement, often used for holding assets on behalf of minor children.
- A disabled persons or vulnerable persons trust – used to hold assets for vulnerable or disabled beneficiaries. Such trusts have specific tax rules and certain tax exemptions.
- Charitable trust – a trust established to benefit charitable causes - see our separate article for more information here.
- A discounted gift trust – used as a specific inheritance tax ("IHT") planning arrangement usually in conjunction with a specific investment product.
When should they be considered?
- Assets within a family trust are safeguarded by the trustees. This means that they are particularly useful in circumstances where there may be any concern as to the desire or ability of the beneficiaries to manage the assets appropriately.
- Trusts can help protect against claims arising as a result of divorce, or business creditors.
- Where a family's wealth is held in a trading business or agricultural land, a trust can avoid ownership and control being broadened across multiple family members and non-family members in the future.
- If such assets are to be sold, trusts can allow advantage to be taken of certain reliefs that may no longer be available following the sale.
- Trusts can help ensure that your current spouse and dependants, and dependants from a previous relationship are all appropriately provided for following your death.
- For non–UK domiciled individuals, holding certain assets in a trust with non-UK resident trustees can be tax efficient. This is an area where change is anticipated so timely formal advice should always be taken.
When are they not appropriate?
- Due to the upfront and ongoing tax costs associated with the establishment of certain trusts (see below), where families have no concerns with making direct gifts of cash or assets to younger generations, a trust is unlikely to provide any advantage and may add additional administrative and tax costs.
- Where beneficiaries are spread around the globe, adverse tax implications in some jurisdictions can at times outweigh the potential benefits.
What are the tax implications?
A key feature of most trusts is that the assets held by the trustees fall outside of the estate of the settlor, provided the settlor survives for 7 years after making the transfer of the assets into the trust and cannot benefit from the trust.
This means that the assets held 'in trust' are not subject to IHT (at rates of up to 40%) upon the death of the settlor. There are however potential IHT charges on establishment of the trust, at regular 10-year intervals during the life of the trust, and on the transfer of assets out of the trust.
Where the assets of the trust generate income or are sold, a separate tax return is normally required by the trustees to report this income or capital gain/loss and pay tax appropriately. The different types of trust have different rules and tax rates on income and gains.
What are the roles and obligations of a trustee?
We will be discussing this in a separate article to be released shortly.
What do we mean by a Family Trust and when might one be considered?
A family trust normally refers to a trust that has been established to hold family wealth across generations, with the trustees often having full discretion over how and when individuals may benefit. One might be set up during the lifetime of an individual (if tax efficient to do so) or perhaps under the terms of the Will.
A common example of a family trust is as follows.
- An individual wishes to pass the value of certain assets onto their children and future generations, whilst still maintaining some control over the assets and protecting them from claims arising, for example on divorce.
- They will pass the assets into the legal ownership of trustees, who may be that individual, their spouse, and perhaps a professional such as a solicitor. The trust is for the benefit of their children and future generations. For as long as the assets are 'in trust', the trustees have control over them and must act in the best interests of the beneficiaries of the trust. Inheritance tax charges can apply on establishment of the trust, however, relief is often available where the assets are shares in a trading business or land and buildings with agricultural use.
- From the moment the settlor passes assets into a trust, those assets cease to be their property and they cede control to the trustees. Unless they are also a beneficiary of the trust they cannot benefit from the trust assets (where they are a beneficiary this can significantly alter the tax profile of the trust).
- For assets that generate income (such as property income, or dividends from shares), this income accrues to the trustees and can then be paid out to beneficiaries. The assets themselves can, subject to the terms of the trust, be transferred to beneficiaries of the trust.
One might consider such an approach where it is felt beneficial for the family wealth to be consolidated into a structure that can then flexibly provide for different members of the family, whilst being protected (to a degree) from IHT associated with the death of family members who might otherwise hold assets personally.
What other options do families have?
If you do not feel that a family trust is right for you but do not wish to make outright gifts to your children, you may wish to consider using a Family Investment Company, and more information on this option can be found here.
How might the rules change in the future?
IHT has been a focus of political debate more recently, with various government and non-government bodies setting out possible changes to the IHT regime, such as changing the way that certain reliefs work. However, to date, The Labour Party have not given definitive views on the future of IHT, or indeed the specific reliefs.
How can we help?
Whatever your circumstances we can advise on the suitability of the different options available to you. If you would like guidance on setting up your own family trust we have a team of experts who can help.