Trusts

A discretionary trust is a flexible trust that can include a wide class of people as potential beneficiaries, including (but not limited to) a surviving spouse, children and grandchildren. I have suggested that you leave a gift equal to the Nil Rate Band amount (this is a maximum sum that can be given before IHT is payable and is currently set at £325,000) into a Discretionary Trust. The trustees can assess the needs of the surviving spouse (and other beneficiaries) and make distributions of capital or income to them as appropriate. The surviving spouse can benefit from the trust (at the discretion of the trustees), but the trust will not be in the surviving spouse’s estate for inheritance tax purposes.

A Discretionary Trust is a flexible trust under which no beneficiary has an automatic right to income or capital as it arises. The Trustees have the power to decide who should receive the capital or income from the trust based on the class of beneficiaries listed within the Will and the trust can run for up to 125 years.

Advantages of a NRBDT

You may wish to make some provision for children or grandchildren however retain the flexibility to review the family circumstances before making a decision. For example, your grandchildren are still minors in which case you may want the trustees to wait until they get older before giving them significant funds.

You may also want the Trustees to be absolutely certain that the survivor of you will be well looked after before transferring assets to other beneficiaries therefore the Trustees retain control of the monies before diverting funds to the other beneficiaries.

In any of these cases, an NRBDT would be preferable to giving the assets to the children or grandchildren outright.

Depending on the size of the estate, an NRBDT can provide some measure of protection from care home fees. The value of the trust would not be taken into account for any assessment for care funding on the surviving spouse.

If the surviving spouse was to remarry the value of the Trust Fund would not form part of their estate and therefore the survivor’s new spouse would not benefit from this trust, unless the Trustees wished them to do so.

If the surviving spouse wishes to make capital payments to children or grandchildren from their own funds they would be known as potentially exempt transfers and subject to the seven year rule. In other words the surviving spouse would need to survive a further seven years after the gift before the value of the gift falls outside of the estate. If the gifts are made from the trust however they are simply appointments of capital from the trust and not subject to the same seven year rule.

You should be aware that Discretionary Trusts are known as relevant property trusts which have their own tax regime. With all these benefits and flexibilities how the trust is taxed should be considered.

As the Trust is its own entity and the value of the trust assets fall outside of anyone’s estate, HMRC makes a charge for Inheritance Tax every ten years during the existence of the trust. The ten year anniversaries are counted from the date of the creation of the trust e.g. the first death.

The charge will be at a maximum rate of 6% on the amount by which the value of the trust fund at the time exceeds the then current Nil Rate Band. As you are aware, the value of the current Nil Rate Band for 2019/2020 is £325,000, however, this may increase in the future. If the Trust Fund is distributed in its entirety before the ten year anniversary there will no ten year anniversary charge.

If the Trust Fund is in place for more than ten years there may also be a charge for Inheritance Tax when the entire trust fund or part of it is distributed to one or more of the beneficiaries. This will depend on the total value of the distributions made during the last ten years of the trust. The top rate which could be charged is again 6%.

 

Depending on what assets the trust holds there may be Capital Gains Tax when a disposal is made by the Trust. The distribution to a beneficiary is treated as a disposal from a Capital Gains Tax perspective and there may be tax payable on the distribution of certain assets based on the market value of those assets at the time if there has been an increase in the value of the asset since it entered the Trust.

The trustees of discretionary trusts have an annual Capital Gains Tax allowance of £6,000 (2019/2020), compared to an individual’s allowance of £12,000. Any gain above this amount is taxable at 28% on residential property and 20% on other assets.

Trustees are responsible for paying tax on income received by the Trust. The first £1,000 of income is taxed at the standard rate of 7.5% for dividend income and 20% for other income. Any gross income received by the Trust above £1,000 is taxable at the trust tax rate of 45% (2019/2020) except for dividends which are taxable at 38.1% (2019/2020).

If the trustees make a payment of income to a beneficiary who pays tax at less than 45%, the beneficiary can reclaim tax (except in the case of dividends) so that he finishes up suffering no more tax than would have been suffered if the trust assets had been his own.

You should be aware that there are tax considerations and administration costs and responsibilities in running the trust. However the advantages (particularly the flexibility of the trust and the growth falling outside of the estate) should outweigh the administrative burdens.