Wednesday, 15 May 2013 12:54
Technical Update: Trusts and Estate Planning
In this edition of Technical Update Jeremy Passmore, a Partner and Head of Private Client for Thomson Snell & Passmore Solicitors in Tunbridge Wells, Kent, looks at trusts and their pivotal role in estate and Financial Planning strategies.
Mr Passmore, who has worked in this area for many years and was an early board member of the IFP, believes the importance of trusts is unaltered but their complexity is growing and the number of restrictions imposed by successive governments will continue to grow in future.
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Despite this, he believs that trusts remain invaluable when it comes to Inheritance Tax Planning and estate planning generaly. For example, one area that has remained relatively unscathed, and where the tax regime is "very generous", is that applying to trusts within the relevant property regime.
In this insightful article he looks at trusts in details and their important when it comes to estate planning, pointing out opportunities and pitfalls to avoid.
To suggest ideas for Technical Update email editor Kevin O'Donnell at This email address is being protected from spambots. You need JavaScript enabled to view it.
IHT, Trusts and Multiple Nil Rate Bands
Trusts have long been used as a key component of estate and financial planning strategies, for individuals with sufficient wealth to be concerned about the impact of inheritance tax. Over the years, governments have taken differing attitudes to trusts and their uses, but the general trend in recent times has been to impose restrictions, and to increase the level of tax that trusts suffer, and thereby to restrict their uses for estate planning.
One area that has remained relatively unscathed, and where the tax regime is really very generous, is that applying to trusts within the relevant property regime. These are trusts with no interests in possession and this used to mean discretionary trusts, but following the 2006 changes now include nearly all lifetime trusts, whatever their internal structure. An old accumulation and maintenance trust will have moved into the relevant property regime in 2008, and any new life interest trust set up in the settlor's lifetime will also, perhaps surprisingly, be treated as a discretionary trust.
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You may well be familiar with the principles of the way tax is charged on such trusts. Any payment into trust creating or adding to the trust is a chargeable transfer and taxable to the extent that the total of chargeable transfers made by that individual in a seven year period exceeds £325,000, or whatever the nil rate band is at the time. This threshold could be exceeded if transfers were made using any available exemptions, such as that for normal expenditure out of income, or reliefs such as business property relief. If the threshold is exceeded then, if the transfer is in the settlor's lifetime the tax rate is 20%, and on death 40%.
An essential characteristic of such trusts is that there is no one individual with an interest in possession, so the funds in trust are taxed as a separate entity. The main feature is the periodic or anniversary charge imposed at ten yearly intervals. In addition, IHT is also levied when capital comes out of the trust between ten year anniversaries. At that point there is an exit charge which, once more than ten years have passed, is calculated as a proportion of the last periodic charge.
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The details of the calculation of the ongoing charges are quite complicated, but let us assume for the sake of simplicity that we have a client who has made no previous chargeable transfers and creates no more than one settlement on the date of the transfer with which we are concerned. In that situation, on the first ten year anniversary if the trust has a value of no more than £325,000 then there is no tax payable. As the value increases, the rate of tax climbs from 0% to a maximum of 6%. Multiple trusts are used in an attempt to bring down the rate of tax on larger amounts that are being settled, in effect making use of the nil rate band which each trust will have.
This is where pilot trusts are often used. A pilot trust is simply a trust set up by a settlor in advance of when it is going to be funded, with a nominal capital sum. A spousal by-pass trust is a type of pilot trust often encountered. However, to get the use of multiple nil rate bands, a number of pilot trusts would be set up; this would often be done on separate days to avoid the trusts being related settlements, although this is really not necessary if the pilot trusts only have nominal sums of £10 in them.
One classic situation for using such trusts would be through a Will where ongoing trusts are required, because of the age or nature of the beneficiaries, and one is trying to avoid the higher charges associated with one large more valuable trust. Let us take an example of a testator who wishes to leave £1.2m net on trust for his four children or grandchildren. If he sets up one trust in his Will then, assuming he has made no lifetime transfers prior to his death, and that the nil rate band stays the same, the tax liability after ten years would be at the rate of 4.05% if the trust had not grown in value, or at 4.78125% if it had grown to £1.6m.
If however the testator had set up four lifetime pilot trusts, each with £10 only, and had drafted his Will to leave a quarter of his net estate to each of them, the position would be very different.
If the trusts had not grown in value, each at £300,000 would pay no ten yearly charge as opposed to a total of £48,600 above. If the trusts had grown to £400,000 each, the tax bill would be £4,500 on each, a total of £18,000. Both of these outcomes compare favourably to the figures above which would have applied had only one trust been used.
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It is worth making the point that this strategy has no effect on the inheritance tax payable on the tax payer's death, or indeed on lifetime transfers, but is simply looking to future charges.
This approach can be used in a number of different situations. Essentially they all have one characteristic, namely the wish to have held in trust a reasonably substantial sum, which on its own would be taxed at the top end of the range of charging. Examples might be:
• A trust for assets which benefit from business property relief. Pilot trusts would be very advantageous if it is likely that the assets would be sold in the future and the relief lost. If the business assets are spread across a number of trusts, the ongoing rate can be reduced, possibly to nil.
• Quite a common situation now is a taxpayer who has been widowed and has remarried, who wants to leave assets into trust to use up two available nil rate bands, and where splitting the amount between two separate trusts will bring the rate of tax right down.
• A person who is in a relationship but unmarried, or has a non-domiciled spouse, might wish to use a relevant property trust to avoid a tax charge on the first death and again on the same assets on the second death. As before, splitting the estate between more than one trust would bring down the rates.
• A taxpayer may have built up something of a portfolio of life assurance and personal pension arrangements. Separate trusts set up to receive future death benefits from different policies or schemes will be taxed separately with resulting benefits.
It is worth making the point that a number of trusts actually set up by a Will would be treated as one trust for on-going charging purposes. The same would apply if it was attempted to carve out separate trusts from a discretionary Will, within two years of death, or by Deed of Variation. With all of these the desired result would not be achieved, in the absence of separate trust structures set up in advance.
One restraint on the use of such trusts is often seen to be the cost involved in running multiple structures. If the maximum tax saving is 6% every 10 years, one needs to be sure that the additional trusts do not generate more than 0.6% a year in the way of additional administrative costs. It would normally be possible to avoid this, by setting up the administrative arrangements in an efficient way, with most activity being in relation to the fund as a whole, albeit allocated to and divided between the underlying trusts.
{desktop}{/desktop}{mobile}{/mobile}
The cloud on the horizon is HMRC's thinking that there should be a single nil rate band to share amongst all the trusts set up by one individual. This proposal was put out for consultation in June 2013, as part of a package of measures described by HMRC as simplifying the periodic IHT charge on relevant property trusts. The rule, if it came in, would have been intended to apply to existing as well as new settlements from a given date, and would obviously block the strategy described above.
In the Autumn Statement, as a result of considerable criticism from many sources, it was announced that the measure would be postponed until 2015, and that in the meantime there would be further consultation.
It remains to be seen if the measure is introduced at some stage, which seems quite likely. If it does, then this strategy will be less effective. Does it mean that existing structures should be altered, or no new arrangements entered into?
It is hard to see what steps can be taken with existing trusts, other than to wind up some of them, if it is practical to do so, to reduce the overall aggregate value. However, it would be sensible to consider whether a higher rate of tax, say 6%, whilst worse than what has applied up until now, remains relatively low cost compared to what might be a 40% rate. It would be precipitate however to take any steps now, without knowing if and how the changes are going to be introduced.
As for future planning, the view could be taken that the strategy might still be effective, but even if it is not then no harm is done in the attempt. That is not quite true with trusts that are already in place when any change is introduced, as the additional work and expense of a number of trusts will already have been incurred.
For a structure that has not yet been triggered, in other words a Will for a tax payer who is still living, it is probably still a worthwhile approach to consider, provided things are drafted on a flexible basis so that the multiple trusts can be dispensed with if they cease to have the attraction they have at present. Perhaps a number of pilot trusts, with a discretionary Will to give the necessary flexibility to use the strategy if it is still viable, or to dispense with it and use one trust only if that has turned into the better option.
{desktop}{/desktop}{mobile}{/mobile}
Biography of Writer
Jeremy Passmore is a Partner and Head of Private Client for Thomson Snell & Passmore Solicitors based in Tunbridge Wells Kent. He has worked for many years in the field of estate planning, with expertise in relation to inheritance tax and capital gains tax, tax planning, Will drafting, and in particular the use of trusts for a variety of purposes. For many years he has had an involvement with the Institute of Financial Planning and spent time on the Board in the organisation's early years. He has a strong belief in the value of professional advice in the whole area of estate, tax and financial planning for individuals and their families.
Mr Passmore, who has worked in this area for many years and was an early board member of the IFP, believes the importance of trusts is unaltered but their complexity is growing and the number of restrictions imposed by successive governments will continue to grow in future.
{desktop}{/desktop}{mobile}{/mobile}
Despite this, he believs that trusts remain invaluable when it comes to Inheritance Tax Planning and estate planning generaly. For example, one area that has remained relatively unscathed, and where the tax regime is "very generous", is that applying to trusts within the relevant property regime.
In this insightful article he looks at trusts in details and their important when it comes to estate planning, pointing out opportunities and pitfalls to avoid.
To suggest ideas for Technical Update email editor Kevin O'Donnell at This email address is being protected from spambots. You need JavaScript enabled to view it.
IHT, Trusts and Multiple Nil Rate Bands
Trusts have long been used as a key component of estate and financial planning strategies, for individuals with sufficient wealth to be concerned about the impact of inheritance tax. Over the years, governments have taken differing attitudes to trusts and their uses, but the general trend in recent times has been to impose restrictions, and to increase the level of tax that trusts suffer, and thereby to restrict their uses for estate planning.
One area that has remained relatively unscathed, and where the tax regime is really very generous, is that applying to trusts within the relevant property regime. These are trusts with no interests in possession and this used to mean discretionary trusts, but following the 2006 changes now include nearly all lifetime trusts, whatever their internal structure. An old accumulation and maintenance trust will have moved into the relevant property regime in 2008, and any new life interest trust set up in the settlor's lifetime will also, perhaps surprisingly, be treated as a discretionary trust.
{desktop}{/desktop}{mobile}{/mobile}
You may well be familiar with the principles of the way tax is charged on such trusts. Any payment into trust creating or adding to the trust is a chargeable transfer and taxable to the extent that the total of chargeable transfers made by that individual in a seven year period exceeds £325,000, or whatever the nil rate band is at the time. This threshold could be exceeded if transfers were made using any available exemptions, such as that for normal expenditure out of income, or reliefs such as business property relief. If the threshold is exceeded then, if the transfer is in the settlor's lifetime the tax rate is 20%, and on death 40%.
An essential characteristic of such trusts is that there is no one individual with an interest in possession, so the funds in trust are taxed as a separate entity. The main feature is the periodic or anniversary charge imposed at ten yearly intervals. In addition, IHT is also levied when capital comes out of the trust between ten year anniversaries. At that point there is an exit charge which, once more than ten years have passed, is calculated as a proportion of the last periodic charge.
{desktop}{/desktop}{mobile}{/mobile}
The details of the calculation of the ongoing charges are quite complicated, but let us assume for the sake of simplicity that we have a client who has made no previous chargeable transfers and creates no more than one settlement on the date of the transfer with which we are concerned. In that situation, on the first ten year anniversary if the trust has a value of no more than £325,000 then there is no tax payable. As the value increases, the rate of tax climbs from 0% to a maximum of 6%. Multiple trusts are used in an attempt to bring down the rate of tax on larger amounts that are being settled, in effect making use of the nil rate band which each trust will have.
This is where pilot trusts are often used. A pilot trust is simply a trust set up by a settlor in advance of when it is going to be funded, with a nominal capital sum. A spousal by-pass trust is a type of pilot trust often encountered. However, to get the use of multiple nil rate bands, a number of pilot trusts would be set up; this would often be done on separate days to avoid the trusts being related settlements, although this is really not necessary if the pilot trusts only have nominal sums of £10 in them.
One classic situation for using such trusts would be through a Will where ongoing trusts are required, because of the age or nature of the beneficiaries, and one is trying to avoid the higher charges associated with one large more valuable trust. Let us take an example of a testator who wishes to leave £1.2m net on trust for his four children or grandchildren. If he sets up one trust in his Will then, assuming he has made no lifetime transfers prior to his death, and that the nil rate band stays the same, the tax liability after ten years would be at the rate of 4.05% if the trust had not grown in value, or at 4.78125% if it had grown to £1.6m.
If however the testator had set up four lifetime pilot trusts, each with £10 only, and had drafted his Will to leave a quarter of his net estate to each of them, the position would be very different.
If the trusts had not grown in value, each at £300,000 would pay no ten yearly charge as opposed to a total of £48,600 above. If the trusts had grown to £400,000 each, the tax bill would be £4,500 on each, a total of £18,000. Both of these outcomes compare favourably to the figures above which would have applied had only one trust been used.
{desktop}{/desktop}{mobile}{/mobile}
It is worth making the point that this strategy has no effect on the inheritance tax payable on the tax payer's death, or indeed on lifetime transfers, but is simply looking to future charges.
This approach can be used in a number of different situations. Essentially they all have one characteristic, namely the wish to have held in trust a reasonably substantial sum, which on its own would be taxed at the top end of the range of charging. Examples might be:
• A trust for assets which benefit from business property relief. Pilot trusts would be very advantageous if it is likely that the assets would be sold in the future and the relief lost. If the business assets are spread across a number of trusts, the ongoing rate can be reduced, possibly to nil.
• Quite a common situation now is a taxpayer who has been widowed and has remarried, who wants to leave assets into trust to use up two available nil rate bands, and where splitting the amount between two separate trusts will bring the rate of tax right down.
• A person who is in a relationship but unmarried, or has a non-domiciled spouse, might wish to use a relevant property trust to avoid a tax charge on the first death and again on the same assets on the second death. As before, splitting the estate between more than one trust would bring down the rates.
• A taxpayer may have built up something of a portfolio of life assurance and personal pension arrangements. Separate trusts set up to receive future death benefits from different policies or schemes will be taxed separately with resulting benefits.
It is worth making the point that a number of trusts actually set up by a Will would be treated as one trust for on-going charging purposes. The same would apply if it was attempted to carve out separate trusts from a discretionary Will, within two years of death, or by Deed of Variation. With all of these the desired result would not be achieved, in the absence of separate trust structures set up in advance.
One restraint on the use of such trusts is often seen to be the cost involved in running multiple structures. If the maximum tax saving is 6% every 10 years, one needs to be sure that the additional trusts do not generate more than 0.6% a year in the way of additional administrative costs. It would normally be possible to avoid this, by setting up the administrative arrangements in an efficient way, with most activity being in relation to the fund as a whole, albeit allocated to and divided between the underlying trusts.
{desktop}{/desktop}{mobile}{/mobile}
The cloud on the horizon is HMRC's thinking that there should be a single nil rate band to share amongst all the trusts set up by one individual. This proposal was put out for consultation in June 2013, as part of a package of measures described by HMRC as simplifying the periodic IHT charge on relevant property trusts. The rule, if it came in, would have been intended to apply to existing as well as new settlements from a given date, and would obviously block the strategy described above.
In the Autumn Statement, as a result of considerable criticism from many sources, it was announced that the measure would be postponed until 2015, and that in the meantime there would be further consultation.
It remains to be seen if the measure is introduced at some stage, which seems quite likely. If it does, then this strategy will be less effective. Does it mean that existing structures should be altered, or no new arrangements entered into?
It is hard to see what steps can be taken with existing trusts, other than to wind up some of them, if it is practical to do so, to reduce the overall aggregate value. However, it would be sensible to consider whether a higher rate of tax, say 6%, whilst worse than what has applied up until now, remains relatively low cost compared to what might be a 40% rate. It would be precipitate however to take any steps now, without knowing if and how the changes are going to be introduced.
As for future planning, the view could be taken that the strategy might still be effective, but even if it is not then no harm is done in the attempt. That is not quite true with trusts that are already in place when any change is introduced, as the additional work and expense of a number of trusts will already have been incurred.
For a structure that has not yet been triggered, in other words a Will for a tax payer who is still living, it is probably still a worthwhile approach to consider, provided things are drafted on a flexible basis so that the multiple trusts can be dispensed with if they cease to have the attraction they have at present. Perhaps a number of pilot trusts, with a discretionary Will to give the necessary flexibility to use the strategy if it is still viable, or to dispense with it and use one trust only if that has turned into the better option.
{desktop}{/desktop}{mobile}{/mobile}
Biography of Writer
Jeremy Passmore is a Partner and Head of Private Client for Thomson Snell & Passmore Solicitors based in Tunbridge Wells Kent. He has worked for many years in the field of estate planning, with expertise in relation to inheritance tax and capital gains tax, tax planning, Will drafting, and in particular the use of trusts for a variety of purposes. For many years he has had an involvement with the Institute of Financial Planning and spent time on the Board in the organisation's early years. He has a strong belief in the value of professional advice in the whole area of estate, tax and financial planning for individuals and their families.
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