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Trust lore

I have heard a lot about the recent changes to the rules covering placing assets under trust. I have inherited a lump sum and want to know if it makes sense to use trusts to mitigate inheritance tax.

There are many benefits to be secured by placing life insurance policies and investments under a valid trust. The most obvious is that there is no need to obtain probate before the trust benefits can be paid to the beneficiaries.

Until probate is granted, your estate cannot be passed to your beneficiaries. Obtaining probate takes time and, if you die before making a will, it can take even longer. If assets are held under trust, the trustees do not have to wait for probate to be granted to distribute your estate.

Establishing a trust also gives you a level of control and flexibility over how your estate is distributed on your death. It means that your estate goes to the people you intended. For example, if you owe money when you die, a trust could mean that your estate will go to your loved ones, not your creditors.

A simple trust for the benefit of your spouse and/or children normally offers full protection against bankruptcy. A claim can usually be made only against the investment made or premiums paid and not the value of the plan.

If your life insurance or investments are not held under trust, their value automatically becomes part of your estate, which will increase the chances of inheritance tax being due. Putting assets under trust may mean that inheritance tax can be avoided altogether.

There is no particular wording required to form a trust but the words used must be sufficiently clear to show the intention to create a trust. A written declaration of a trust is normally considered to be a permanent record of the existence of the trust.

The wording can appoint a named beneficiary who cannot be changed, in which case it is known as a fixed or bare trust. Where the beneficiaries can be changed as circumstances alter, it is known as a flexible trust.

Let us go back to basics on what is needed to constitute a valid trust. First, there need to be three parties:

l The settlor who creates the trust and initially owns the policy or plan. This will be you in this case.

l The trustees who look after the trust’s assets and ensure the trust remains legally valid. As the trustees are considered to be the legal owners of the policy or plan, the settlor is automatically a trustee. I recommend that you appoint more than one other trustee because there can be complications if the trustees predecease the beneficiaries. Do not appoint too many trustees, say, more than five, as this can become complex from an administrative point of view.

l The beneficiaries are the people you want to benefit from the assets of the trust.

The 2006 Budget made fundamental changes to the way inheritance tax applies to trusts. These changes have a wide-reaching impact on life insurance and investments held under trust. The changes are intended to align the tax treatment of all trusts so that flexible trusts and accumulation and maintenance trusts will now become subject to the discretionary trust regime. The changes do not affect simple trusts.

Most trusts, whether set up during lifetime or on death, will now be subject to inheritance tax charges during the life of the trust.

Basically, all transfers of value or gifts into a trust will be treated as a chargeable lifetime transfer and not as a potentially exempt transfer. If a gift made by the settlor takes him or her over the nil-rate band on a seven-year cumulative basis, there will be an immediate tax charge of 20 per cent on the excess.

There will also be a periodic tax charge made on the trust every 10 years. This charge could be as high as 6 per cent of the value of the assets held under trust but in many cases it will be a lesser amount.

There will also be an exit charge when capital is taken out of the trust. The amount of tax paid will be calculated depending on the amount of the last periodic charge, the time passed since the last periodic charge was made and the amount of the capital being taken from the trust.

Although these Budget changes made holding assets under trust less attractive, placing investments and life insurance under trust can still save your family thousands of pounds when you die.

Kim North is director at Technology & Technical

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