For many they believe that the use of trusts is something that is reserved for the rich and famous. In reality they should be used by everyone, as the most basic of trusts is a Will. The first thing to explain is what exactly is a trust? HMRC describe a trust as a way of managing assets (money, investments, land or buildings) for people. There are many different types of trusts and they are taxed differently and with many different objectives. The two main ones are for reducing taxes and for the distribution of assets on someone’s death in accordance with their wishes when they die.
Trusts have 3 categories of individuals involved with them:
the ‘settlor’ - the person who puts assets into a trust
the ‘trustee’ - the person who manages the trust
the ‘beneficiary’ - the person who benefits from the trust
Trusts are set up for a number of reasons, including:
to control and protect family assets
when someone’s too young to handle their affairs
when someone can’t handle their affairs because they’re incapacitated
to pass on assets while you’re still alive
to pass on assets when you die (a ‘will trust’)
to allow assets to be passed to specific beneficiaries after death free of inheritance tax
to allow beneficiaries to gain access to inheritance at a specified time in the future
The particular trust I would like to focus on first is a Discounted Gift Trust (DGT). We use this type of trust for clients who want the potential for an immediate and future IHT reduction. They are expected to survive at least seven years and want to still benefit from withdrawals of the original capital in the form of fixed regular payments.
The key difference with this type of trust is the immediate discount which can be gained. As the trust enables the settlor to receive a regular payment, the value of these payments may be discounted for inheritance purposes. The amount of discount considers the amount of payments that the settlor could expect to receive during the rest of their lifetime. This will depend upon things such as their state of health, age and sex. The longer the settlor’s life expectancy the larger the discount should be. As we typically use an investment bond to put into the trust the amount that can be taken as a regular income is 5% of the original investment without creating a tax charge.
If we take the example of Mr Howarth aged 67, he has a house on the outskirts of London worth approximately £750,000. He is single and never married and has no children. He has accumulated cash of around £500,000, £250,000 of which he would like to leave to his nephew. Due to his age and state of health he receives a discount of 40% which means that immediately £100,000 is no longer in his estate. So if he passed away within the first year £100,000 would be outside of his estate. This would give his nephew an immediate cash saving of £40,000 as the amount subject to IHT (40% tax rate) would be reduced from £250,000 to £150,000. The direct benefit to Mr Howarth would be the 5% immediate “income” that he would receive without tax.
The important thing that should be emphasised for DGTs is that the withdrawals produced must be needed as otherwise the money will just fall back into the settlor’s estate. If the income is not needed there are many other types of trusts that could be more suitable. For any financial advice Bradbury Hamilton, are able to advise. Visit www.bradburyhamilton.co.uk or call Sheriar Bradbury on 020 7220 7274 for more information.