Trusts are one of the most valuable financial planning tools, but they are also one of the least-well understood. In this guide we explain what a trust is and why they are used. We then look at the different types of trust and what you need to be aware of if you are involved with one.
The person who wants to set up the trust puts cash or other assets into the treasure chest and locks it. The keys to the treasure chest are held by trustees (usually including the person who sets up the trust). The trustees can unlock the treasure chest, change the assets inside and distribute the contents in line with the terms of the trust.
The settlor (the truster in Scotland) is the person who establishes and puts assets into the trust. Settlors are usually an individual or a couple. We look at the settlor’s responsibilities in more detail.
The trustees are the people who control and oversee the trust. Anybody can act as a trustee as long as they are over 18 and have full mental capacity. Often the settlor will act as a trustee to keep an element of control over the assets. Beneficiaries can also be trustees but this could cause a conflict of interest. If a neutral party is required to act as a trustee, it is also possible to appoint a solicitor. The trustees are responsible for investing the money held in the trust.
The beneficiaries of the trust benefit from the arrangement. For example, they may receive money from the trust or the right to occupy a property. Certain trusts give the trustees discretion over how and when these benefits are given to beneficiaries.
Maintaining control A trust lets you keep control over the assets you placed in it, usually by acting as a trustee, but also under the terms of the trust. By establishing a trust under a Will, you can also ensure that your assets are passed to the right people at the right time after you die.
A common example is when somebody remarries or enters another civil partnership but has children from a previous marriage, civil partnership or relationship.
Usually, they want to ensure their current husband, wife or civil partner is taken care of for the rest of their life, after which the money will pass to their children from the previous relationship. A trust lets them do this.
Trusts offer a means of protecting assets for the beneficiary. If you make an outright gift to a beneficiary who then divorces or goes bankrupt the money could be lost. However, if a gift is made into a trust under which a beneficiary has no right to the money then that gift is much less likely to be taken into account. This is because the trustees can choose not to pass the gift to that beneficiary.
Saving inheritance tax
Trusts offer a useful way to save inheritance tax without having to make an outright gift to another person. If you place assets into a trust from which you cannot benefit, after seven years the assets will fall outside your estate for inheritance tax purposes. Any growth on the assets will immediately be outside your estate
Avoiding probate delays
After you die, inheritance tax and probate fees must be paid before probate is granted and your assets can be distributed in line with your Will. However, the executors of your Will can’t access your estate’s assets until probate is granted, so they must find the money from elsewhere.
As a trust is separate from your estate, your trustees can immediately access any money held in it with no need to wait for probate. The money could then be used to pay the inheritance tax bill and probate fees. It is also possible to set up a life insurance policy that pays a lump sum into a trust when you die. This money would also remain outside your estate and could be used to pay the inheritance tax bill.
A trust is a legal arrangement where someone (the settlor) gives assets to another person (the trustee) to manage on behalf of a third person (the beneficiary). There are different types of trusts and they are taxed differently. The settlor, trustee and beneficiary all have different tax responsibilities.
If your trust is liable for UK taxes, you must usually register it with HM Revenue and Customs (HMRC). This is even if the trust is not liable for UK taxes, unless certain exceptions apply.
As the trustee, you are responsible for reporting and paying tax on behalf of the trust. You must report the trust’s income and gains in a trust and estate Self Assessment tax return after the end of each tax year.
The type of trust you have will determine who is responsible for paying tax on the trust’s income and gains. If you are the beneficiary of a bare trust, you are responsible for paying tax on income from it. If you are the settlor of a settlor-interested trust, you are responsible for Income Tax on the trust income, even if some of the income is not paid out to you.
Bare trust – A bare trust is a simple trust where the beneficiary has an immediate, absolute right to the assets in the trust and the income generated.
Interest in possession trust – An interest in possession trust entitles the beneficiary, as of right, to the trust income as it is generated.
Discretionary trust – A discretionary trust gives the trustees discretion about how the trust’s income and/or capital is used.
Accumulation trust – An accumulation trust allows the trustees to accumulate the trust’s income until the beneficiary is legally entitled to the property or the income generated by the trust.
Mixed trust – A mixed trust is a trust that combines elements of two or more of the other types of trust.
Tax Benefits of a Trust
Inheritance tax (IHT) planning: Trusts can be used to reduce the amount of IHT that is payable when you die. For example, you could put assets into a trust during your lifetime, which would mean that they would not be included in your estate for IHT purposes when you die.
Income tax planning: Trusts can be used to reduce the amount of income tax that is payable. For example, you could put income-producing assets into a trust, which could mean that the income would be taxed at a lower rate.
Capital gains tax (CGT) planning: Trusts can be used to reduce the amount of CGT that is payable. For example, you could sell assets to a trust, which would mean that any gains would be taxed at a lower rate.
Asset protection: Trusts can be used to protect assets from creditors or other claimants. For example, you could put assets into a trust, which would mean that they would not be available to creditors if you were to go bankrupt.
The trust rate of income tax is 45% (39.35% for dividends) Income paid to a beneficiary will come with a tax credit of 45% which may be reclaimable by those who do not pay tax at the top rate.
However, there are some special rules that apply to trusts, such as the £1,000 personal allowance. This means that the first £1,000 of income that a trust receives is taxed at the basic rate of income tax (20%).
Capital gains tax:
Trustees pay 20% Capital Gains Tax on gains made on the sale of assets held in the trust.
However, there are some special rules that apply to trusts, such as the annual exemption. This means that trusts can make gains of up to £12,300 each year without paying any CGT.
Trusts are subject to inheritance tax (IHT) in the same way as individuals. However, there are some special rules that apply to trusts, such as the nil rate band. This means that the first £325,000 of assets that a trust holds is exempt from IHT.
It is important to note that the tax rates for trusts can change, so it is always best to check with HM Revenue and Customs (HMRC) for the latest information.
The trust 10 year rule is a UK tax rule that applies to discretionary trusts. It states that if a discretionary trust has been in existence for more than 10 years, then any gains made on the sale of assets held in the trust will be taxed at the lower rate of capital gains tax (CGT).
The trust 10 year rule is designed to encourage people to set up discretionary trusts and to hold assets in them for a long period of time. This is because the lower rate of CGT can save the trustees a significant amount of money.
However, it is important to note that the trust 10 year rule does not apply to all discretionary trusts. For example, it does not apply to trusts that were set up for the purpose of avoiding tax.
If you are considering setting up a discretionary trust, you should seek professional advice to ensure that you understand the trust 10 year rule and how it may affect you.
Here are some examples of how the trust 10 year rule can work:
A trust is set up in 2013 and holds a property worth £100,000.
The property is sold in 2023 for £150,000.
The trustees of the trust would normally have to pay CGT on the £50,000 gain at the higher rate of 28%.
However, because the trust has been in existence for more than 10 years, the trustees can pay CGT on the gain at the lower rate of 18%.
This means that the trustees would save £7,000 in CGT (£50,000 x 28% – £50,000 x 18%).
The trust 10 year rule is a complex area of tax law and it is important to seek professional advice if you are considering setting up a discretionary trust.
The trust 10-year charge is a UK tax charge that applies to discretionary trusts. It is a charge on the value of the trust assets on the 10th anniversary of the trust’s creation, and on every 10th anniversary thereafter. The charge is calculated at 6% of the value of the trust assets, and is payable by the trustees of the trust.
The trust 10-year charge is designed to ensure that discretionary trusts do not become a way of avoiding inheritance tax. Discretionary trusts are often used to hold assets on behalf of beneficiaries, such as children or grandchildren. This can be done in order to protect the assets from creditors or other claimants, or to ensure that the assets are distributed in a particular way after the death of the settlor.
However, if the assets in a discretionary trust are not distributed within 10 years of the trust’s creation, then the trustees will be liable to pay the trust 10-year charge. This means that the trustees will have to pay tax on the value of the assets, even though they have not yet been distributed to the beneficiaries.
The trust 10-year charge is a complex area of tax law, and it is important to seek professional advice if you are considering setting up a discretionary trust.
At outsourced ACC we work with our clients to ensure they are forward thinking and plan taking in to account all available benefits under trust. For clients who already have trusts its ensure you correctly report income and pay taxes. Planning can against assist you with this. Give us a ring and speak to our expert in Trusts.