Estate planning can be described as planning for the transfer of assets to the future generations in the most tax efficient way, while talking account of the personal circumstances and the legal and moral obligations to dependants either by way of lifetime gift or will.
A trust is a legal instrument whereby a person (known as the ‘Settlor’) places ownership of assets under the control of another person (known as the ‘Trustee’) for the benefit of someone else (known as the ‘Beneficiary’) or for a specified purpose. A trust can be set up either by lifetime deed or by will.
Commonly used types of trust include:
- Fixed Trusts in which each Beneficiary has a fixed entitlement to a specific share or interest in the trust property. For example, the Trustees might hold property equally between children of the Settlor to be paid to them upon reaching 25 years of age.
- Interest in Possession Trusts, for example a life interest in the trust property. This type of trust may be appropriate in the context of a second relationship or marriage where the Settlor is anxious to provide for his or her new partner while at the same time protecting the assets for the benefit of his or her children.
- Bare Trusts arise where property is held by the Trustees as nominees for the Beneficiary, for example an asset acquired by a parent for a minor child who, because of his or her minority, may not hold the assets directly.
- Discretionary Trusts arise where the trust property is held by the Trustees on trust for the benefit of the members of a specified class of Beneficiaries. Effectively the trustees have a discretion as to which beneficiary will receive trust assets and when. The Beneficiaries have no interest in the trust fund for legal or taxation purposes. They merely have the right to be considered favourably by the trustees for an appointment of property or income from the trust fund.
Trusts in general and discretionary trusts in particular are very useful vehicles which can assist greatly in succession planning. They offer a large degree of flexibility in particular in providing for young children, beneficiaries with disabilities, vulnerable adult beneficiaries or situations where there are subsequent relationships.
Because the Beneficiaries of a discretionary trust have no interest in the trust fund the placing of assets in a discretionary trust does not give rise to a charge to Capital Acquisitions Tax (CAT). It is only when assets are appointed out of the trust to a particular Beneficiary that a charge to CAT arises. Discretionary trusts are accordingly particularly useful for the following:
- Ring-fencing and protecting certain assets.
- To hold asset for young children (assets either passing on death or during lifetime).
- Preserving assets for future generations – rather than passing all assets to the next generation only.
- Providing for children with disabilities.
- Providing for children who cannot manage their own affairs (for reasons other than a disability e.g. addiction).
- Providing for a non-marital partner.
- Maximising tax planning opportunities by allowing time to satisfy the conditions of various reliefs.
It is usual for the Settlor of a Discretionary trust to write a letter of wishes to the Trustees providing the Trustees with guidelines as to how he or she would like the trust fund to be distributed. While such a letter is not Binding on the Trustees, the Trustees will usually take into account the Settlor’s wishes. This is particularly useful in the case of trusts for very young children where it is difficult to know at the time creating the trust what their individual needs might be years into the future as it allows the Trustees flexibility in making fair and equitable provision for the children in light of each of their needs and circumstances.
Because the charge to CAT only arises when assets are appointed out of a discretionary trust such trusts were often used to defer the CAT liability. To counteract this Discretionary Trust Tax (DTT) was introduced in 1984.
The tax comprises an initial charge of 6% and an annual charge of 1%. If however the trust is wound up within a period of five years half of the initial charge is refunded, reducing it to 3%.
The charge to DTT in respect of a discretionary trust arises on the later of the death of the Settlor or the date on which there are no “principal objects” under the age of 21 years, principal objects being the spouse, children or minor children of a predeceased child of the Settlor. There are also, subject to certain conditions, exemptions available in respect of discretionary trusts for the benefit of persons with disabilities and vulnerable adults.
The charge to DTT will if the Settlor is dead arise when the youngest child turns 21. The charge could be avoided by appointing all of the assets out of the trust or changing the terms of the trust in advance of this. Alternatively, a view could be taken that the tax is a worthwhile cost in ensuring that a child does not come into significant assets at too young an age.
If you would like more information on this topic or on estate planning in general, please contact Patrick Bradley, Partner, by email at firstname.lastname@example.org.