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Trust in the future

22 October 2014

Trusts play an important role with many families of today, protecting wealth for generations to come – and as their attractiveness increases their value will continue to grow.

The beneficiaries of trusts can thank the Romans and then the Crusaders for the development of this very particular way of holding assets and passing them down the generations.

The Romans developed the basic idea and then, as they left for the Holy Land, the Crusaders expanded the trust principle to enable them to undertake long voyages without losing their lands.

And in the modern world trusts still play an important role in many families. In fact, as family structures become more complicated – with family members increasingly spread around the world, people living longer and more getting divorced – it could be said that the value of trusts continues to grow. So what are the pros and cons? And what are the points you should watch out for?

The main advantage is that donors can make gifts without restricting themselves too much as to who the recipients will be. Someone with children and growing numbers of grandchildren can set up a trust which will, eventually, pay out to family members who are yet to be born.

Similarly, trust assets can be protected by excluding descendants who are in danger of going bankrupt or those getting divorced from being potential beneficiaries.

Divorce is one of the most common threats to families who want to pass on money. The problem is that someone receiving money from their parents can find that they have to give away half of those assets to their former partners in a divorce settlement. And personal bankruptcies, which are growing more common with more than 100,000 a year in the UK¹, present similar problems.

Trusts are also a way of saving Inheritance Tax, although the amounts protected are being reduced in some cases. Putting assets into trust gradually removes them, over a seven-year period, from the individual’s estate at death and this can cut the tax bill, although there are anti-avoidance rules that must be navigated.

Tony Müdd, divisional director of Tax and Technical Support at St. James’s Place, believes that the changing face of the UK tax system could have an impact on the types of trust structures that will be used in future. ‘But one thing is for sure, tax changes will never make them redundant,’ he says.

Another advantage of the trust structure is speed as they can pay out immediately after the settlor, the person who set them up, dies – in contrast towills, where delays of several months are commonplace.  However, there are disadvantages. In France, the Loi de Finances Rectificative 2011 – the French equivalent of our budget – affected French resident settlors or beneficiaries and French assets of UK trusts, and may well mean that some assets are subject to wealth taxes in France.

In the UK, meanwhile, tax reforms expected next year (see above) could confuse and put off some potential settlors. The changes will also reduce the tax savings available in some cases. Trusts need to be reviewed regularly to ensure that they conform to existing tax law and to prevent mistakes being made. Even a change as simple as adding the name of a new grandchild to the list of beneficiaries can trigger a series of unintended consequences. There are, however, a variety of ways of carrying out the settlor’s wishes through trusts; in this case, the grandchild can be included without his or her name being stated, but you should ensure you take the appropriate advice.

Types of trust

Two of the simplest, and most common, types of trust are seven-year trusts and loan trusts. They are set up in the ways that their names suggest. Seven-year trusts are established by the same settlor every seven years to take advantage of rules which extinguish a potential Inheritance Tax (IHT) liability seven years after a transfer of that asset has been made. With a loan trust, the settlor creates a trust and lends assets to it, with any profits generated staying in the trust and, therefore, outside the settlor’s IHT net.

These and other kinds of trusts are still being set up, but new rules are being drafted by the UK government that will reduce their attractiveness for some people. The new rules – with the clumsy title of the ‘settlement nil-rate band’ – will mean that many trusts will offer less IHT protection.

In effect, HM Revenue & Customs is proposing that individuals have a lifetime allowance on how much they could transfer tax-free into trusts – this lifetime allowance would be set at £325,000 (the same level as the IHT ‘nil-rate band’ on the estates of individuals when they die). The move is part of the current political agenda to increase tax transparency.

Trust structures could still work for many people, but calculations should be performed in advance to estimate both any likely tax charges and the overall tax benefit that the trusts produce. Dominic Potier of solicitors Wedlake Bell says: ‘It depends on the client and on whether they are prepared to take any tax hits.’ Tony Müdd says that more tax will be paid as a result of this change, but adds: ‘Trusts will always be worthwhile.’

1 www.gov.uk

Trusts are not regulated by the Financial Conduct Authority.

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