Using trusts to preserve wealth for future generations
By Paul Allan, an Independent Financial Adviser in Wren Sterling’s Glasgow office. There will be a time when we’re no longer able to manage our money, but that doesn’t mean that we’re not able to choose how it should be used. Trusts can be used to protect your assets for future use. Like many financial instruments, there are several different types of trust, and ways to use them – from tax purposes to estate planning. When used appropriately, trusts can be one of the most effective tools in a financial adviser’s toolbox.
What is a trust?
Trusts allow you to set aside assets for specified beneficiaries. You can put conditions on how the trust is used, who will benefit from the assets (beneficiaries), and who will manage them (trustees). You can even choose to give your trustees powers over the trust – to make decisions about releasing assets (perhaps for young beneficiaries, allowing the funds to be used for university fees or buying their first home).
When you’re creating a trust, you need to decide whether you want to put any conditions on it, as trusts will become a separate legal entity, and the assets placed in trust no longer belong to you (the settlor).
Did you know you may already have a trust – or even more than one? Your pension funds will be held in a discretionary trust, helping you put money aside for your future needs.
Arranging a trust
Taking advice when setting up a trust is invaluable – as the legal wording needs to be precise, and you’ll need to choose your trustees and beneficiaries very carefully. There are fees associated with setting up a trust, but talking with your financial adviser beforehand could help you decide whether or not a trust is the most appropriate way to achieve what you want. It will also let you know whether a solicitor should be involved (depending on the complexity of your situation). As there are several types of trusts, and many other financial products, there may be more appropriate ways to structure your finances. A financial adviser can help you to structure a financial plan, mapping out your future needs and how your finances can be used to meet them. In this article, we’re going to look at different ways that trusts can be used, and why you might consider using them.
Using trusts to safeguard your assets
When considering a life assurance policy to protect your spouse, partner, or your children on your death, you could consider putting it in trust. Let’s look at an example.
Alan purchases life insurance to protect his family upon his death. If this policy is not placed in trust, the money from this policy will form part of his estate, and may be subject to inheritance tax (IHT). Without a trust, this payment could be delayed until confirmation or probate is obtained, and the funds would not be available to Alan’s children to pay for funeral expenses and other costs. If the policy was placed in a trust, the sum would be available immediately to Alan’s beneficiaries and would not be considered part of his estate.
By using a Discretionary Trust, if Alan dies during the term of his Life Assurance plan, the trustees have discretionary powers over how the trust assets can be used for the benefit of his chosen beneficiaries. This is particularly useful if the beneficiaries are minors at the date of Alan’s death. The trustees could decide to provide a regular income stream, ad-hoc withdrawals, or if appropriate pay out the entire trust proceeds. The key here is that they have discretion and an obligation to act in the beneficiaries’ best interests in relation to the trust assets.
By placing their Life Assurance plan in trust, the settlor (Alan) is able to make the monies more freely available upon his death, avoid unnecessary tax, and create a framework where his trustees can have some control over how to use the trust assets for his chosen beneficiaries.
Protecting your property
Including a trust in your Will is one way you can protect your home for your spouse and your descendants. Care costs are means-tested, and depending on where you live and the cost of your care, your home and your legacy could be used to pay for care fees.
An elderly couple, John and Mary, are worried that if their health deteriorates, the value of their family home might be swallowed up by care costs. While they are in good health now, they own their home jointly, and have a joint Will that currently leaves everything to each other, and then to their children. They decide to consult a financial adviser to discuss their options.
After considering several options, Mary and John take their adviser’s recommendation and Split Title on the property (often called ‘Tenants in Common’) and create a new Will trust. Now if either partner were to die, the deceased’s half of their property goes into trust to provide a legacy for their children, rather than allowing the whole of the value of their property to be used for care costs.
After making this new Will, imagine that five years later John needs to go into a care home. As long as Mary remains in the family home, it is normally disregarded when paying for care fees. But what if six months later, Mary died unexpectedly? Without the new Will, the whole value of their home could be used to pay for John’s care as he would have inherited the whole property.
Trusts are also very widely used in IHT planning. The two examples we have discussed in this article both concern ways to use ‘Will trusts’ – trusts that only take effect once you pass away. But there are many different types of trusts, and depending on your unique financial situation and what you want to do with your money, a financial adviser can help you consider which options could work best as part of your financial plan.
Placing assets in a trust may ensure that they are no longer considered to belong to the settlor, and are not taken into account in their IHT bill. Using a trust means that the settlor doesn’t have to hand over control of those assets in their lifetime, and allows assets to be managed for young or vulnerable beneficiaries.
Let’s look at an example. Daniel and Olivia have both turned 70. Recent press articles have made them aware that when they die, their children Sarah and Colin are likely to have an IHT bill to pay and they would like to take steps to reduce it. Currently, their Will leaves all their estate to each other on first death and then is split equally between Sarah and Colin on second death. Daniel and Olivia decide to get help from a financial adviser to find out their options.
Currently, their total estate is valued at £1,150,000. To work out their current IHT liability upon the second death, they would need to consider their Personal Nil Rate band (NRB) and Main Residence Nil Rate band (MRNRB):
|Total estate value:||£1,150,000|
|Personal Nil Rate band:|
(£325,000 for the 2018/9 tax year; this is doubled as this case includes both spouses' NRB)
|Main Residence Nil Rate Band: (£125,000 for 2018/9 tax year; doubled as this case includes both spouses' MRNRB)*||£250,000|
|Amount liable for IHT:||£250,000|
|Rate of IHT:||40%|
|Amount to be paid:||£100,000|
*As the MRNRB will rise to £175,000 by 2020/21, Daniel and Olivia’s IHT bill will reduce in future to 40 per cent of £200,000 (£80,000).
Having discussed Daniel and Olivia’s current financial situation, their adviser will create a plan based on how they wish to use their money, and help them achieve their financial objectives. In the following three examples, their aim is the same – to reduce their IHT liability – but the financial situations are quite different.
Discretionary Gift Trust:
Let’s say Daniel and Olivia have a high level of pension income, and don’t rely on their savings.
They could choose to place a sum into a Discretionary Gift Trust. This allows them to give this money away, but exercise some control as to when these assets are paid to Sarah and Colin.
Impact of this trust: All capital will be excluded from any IHT calculations after seven years, and will be available to Sarah and Colin whenever the trustees decide to distribute it. Any growth on the original gifted amount is outside their estate immediately.
Discounted Gift Trust:
If Daniel and Olivia don’t have a large pension income and rely on their savings to supplement their income.
A Discounted Gift Trust could provide Daniel and Olivia with an income stream from the trust for life to supplement their pension income. On death, any residual value will go to Sarah and Colin.
Impact of this trust: A proportion of the initial value of the trust is ‘discounted’ or leaves the estate immediately, reducing the immediate IHT liability. The income from the trust is paid to Daniel and Olivia until either the trust assets are exhausted or for life. After seven years, the trust assets are outside the estate, and on death any residual value is paid directly to Colin and Sarah.
If Daniel and Olivia had an adequate income, but were concerned that their capital needs may grow in the future.
They would like to set aside future monies for their children, but would also like to be able to draw down these monies should they need them in the future – or in other words, call in their loan in the form of regular withdrawals.
Impact of this trust: The original capital investment belongs to the settlor as they have loaned this money to the trust. They could choose whether to draw down none, some, or all of this capital during their lifetime. Any growth on the trust assets belongs to the beneficiaries and passes outside the settlor’s estate immediately.
How will Daniel and Olivia decide which trust to use?
With help from their financial adviser Daniel and Olivia can discuss their options and consider whether they want to use a trust, and which to use. They will need to consider their futures as they may not be able to access their funds once they are placed in trust (depending on the plan they put in place).
The Financial Conduct Authority does not regulate taxation and trust advice or will writing.
The scenarios in this article are fictional.
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