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Different
types of Trusts.
Bare
Trust
Discretionary
Trust
Accumulation
and Maintenance Settlements
Life
Interest Trusts
Questionnaire
A trust is a means of holding money for designated
individuals without giving immediate access to the fund. The usual
reasons for creating a trust are:
- To protect beneficiaries from themselves or
from third parties
- To facilitate in making a gift at a time when
the beneficiary is too young or immature to hold the gift himself
- To dispose of property by the donor for tax
saving purposes without giving an immediate right to a beneficiary
Certain rules apply to all trusts:
- It is imperative to be tax efficient that if
a settlement is created during lifetime that the Settlor and spouse
retain no interest in it. Thus a default beneficiary must be appointed
in the deed to inherit should the primary trust fail
- Additional assets can be added to the trust
at any time
- Unless power is retained in the settlement
deed it is not possible to add to the class of beneficiaries at
a later date, although such class can be widely drawn in the first
instance (e.g. all my grandchildren born before……….)
- No trust can last indefinitely and there are
complex rules dealing with this. Most trusts now are drafted to
end after 80 years but this can of course be reduced either at
drafting or later if the Trustees have the power to terminate
the trust earlier.
- Generally income can be accumulated by the
Trustees, but the law provides that the right to accumulate cannot
last indefinitely. Usually this is limited to 21 years.
There are basically four types of trust.
Bare
Trust
A Bare Trust exists when a nominee holds the
property directly for another. The beneficiary is entitled to
call for the property at any time, and the taxation effect of
such a trust is as if no trust exists. It is usually used where
an owner does not wish to be identified by such third parties.
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Discretionary
Trust
This is the most flexible form of trust in that
no beneficiary is ever entitled to capital or income until the
Trustees decide to appoint one or more of the beneficiaries. As
an exercise in protecting money for an individual, or for tax
planning by generation stepping, or where one is not certain who
one wants to benefit, it is ideal. For example the fact that one
is a beneficiary of a discretionary trust (DT) cannot be taken
into account in insolvency or divorce proceedings or by the DSS
or Local Authority unless of course money is actually paid out
to the beneficiary by the Trustees.
A gift into a DT is
not a Potentially Exempt Transfer (PET) for Inheritance Tax (IHT)
purposes. However if you have made no lifetime gifts other than
within the usual exemptions, there will be no tax to pay unless
the amount settled exceeds your nil rate band (currently £255,000).
Once the settlement is created there will be no further IHT within
the trust rules unless the trust assets (when aggregated with
the settlor’s previous gifts) exceed the current nil rate
band from time to time. There will then be a ten yearly charge
to IHT which works out currently at 6% of the value of the trust.
If the value of the fund exceeds the nil rate band there will
also be exit charges to IHT on gifts out of the settlement to
beneficiaries, or on the termination of the trust.
The trust will have
its own identity for Capital Gains Tax (CGT) which is levied at
34% but its exemption will be £3,950 (one half of the individual’s
allowance).
Income tax within
a DT is at 34%. However beneficiaries who receive income can reclaim
the excess tax above their own tax rate or credit the tax against
a higher rate.
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Accumulation
and Maintenance Settlements
These are quite tax effective. However the beneficiaries
should be the children or grandchildren of a common grandparent
(the parent or grandparent need not be the settlor), and the beneficiaries
must become entitled to either the income or the capital on or
before reaching the age of 25. Subject thereto they can be quite
flexibly drawn and the beneficiaries shares can be left to be
determined by the trustees.
A gift into an AMS
is a PET, and so no IHT is payable unless the settlor dies within
7 years of the gift. Then the gift would be aggregated with the
deceased’s free estate and tax payable by the Trustees if
the taxable estate exceeds the nil rate band. The trust however
may not bear tax if the value of the original gift is still within
the deceased’s nil rate band, as it will take the first
bite of the nil rate band unless there have been earlier aggregable
gifts.
There will be no IHT
payable on a beneficiary becoming entitled to capital or income.
The taxation consequences
of an AMS for CGT and Income Tax (IT) are as above for DT unless
for Income tax purposes of a beneficiary has an absolute right
to receive the income when the income tax rate is 34% in the hands
of the trustees and the beneficiary either reclaims the tax paid
or pays any additional tax at their own rate of IT.
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Life
Interest Trusts
Such trusts are held to pay the income to a
named beneficiary until a certain date (e.g. their death, remarriage
or a particular age). A trust can be drafted to have a succession
of life tenants (the beneficiary entitled to receive the income),
but must terminate within the usual 80 years by passing to someone
outright.
Again a gift into such
a trust is a PET, so not tax will be payable unless the circumstances
above for AMS occur. Thereafter the IHT treatment is as if the
beneficiary were the owner of the trust property although any
tax payable is borne by the trustees. Accordingly IHT could occur
if the value of the trust, when aggregated with their own property,
exceeds the Life Tenants nil rate band on termination of their
interest.
For CGT the trustees
have their own exemption of £3,950 per year. CGT is charged
at the trust rate of 34%. Income tax is paid by the trustees at
basic rate, but the income is treated as that of the beneficiary
and additional tax paid by the beneficiary if their own resources
mean they are liable to income tax at a higher rate.
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Summary
Should you wish to consider creating a settlement
please contact Nick Pinks who will be happy to advise you in the
preparation of a suitable document and to discuss the tax implications
in greater detail.
Please note that this
summary is not intended to provide solutions to particular problems
and readers should take advice with regard to their particular
circumstances.
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