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Trustees turning to Advisers

Accepting an appointment as a trustee should not be taken lightly.

Trustees have big responsibilities and if these are ignored or

trustees overstep the mark, they can find themselves personally

liable for any losses that the beneficiaries suffer as a result.

However, the enactment of the Trustee Act 2000 will have made life a

little easier for trustees in some ways and will certainly have

provided openings for financial advisers.

The act applies to any trust subject to the law of England and Wales,

whether the trust was created before or after the start of the Act

and the Trustee Act (Northern Ireland) 2001 has broadly similar

provisions. A consultation paper on Scottish trusts is expected soon.

Before these acts came into force, trustees who had no investment

powers specified in the trust document were restricted to those

investments authorised under the Trustee Investments Act 1961. These

were largely unexciting and relatively safe and investment in the

form of an insurance policy was conspicuous by its absence.

The Trustee Act 2000, however, is much more open. Section 3(1) allows

a trustee to make any kind of investment that they could make if they

were absolutely entitled to the assets of the trust, unless the trust

document specifies otherwise.

The considerable advantages associated with investment in life

policies are now available to most, if not all, trustees. However,

section 4 of the act makes it clear that when investing trust assets,

the trustees must have regard to the suitability of the chosen

investments as well as the need for diversification. Clearly, these

aspects should always have been uppermost in trustees&#39 minds even

before the act came into force but they are now statutory

requirements.

In what circumstances might a life policy investment be unsuitable?

It is not uncommon for a trust to be written in such a way that a

beneficiary (the “life tenant”) is entitled to the income produced by

the trust investments during his/her lifetime. Other beneficiaries

(the “remaindermen”) would then be entitled to the trust capital when

the life tenant dies. In such circumstances, it might not be suitable

for the whole trust fund to be invested in a life policy, as all life

policies are non-income-producing assets.

Although most single-premium bonds will allow regular withdrawals

(which are sometimes referred to in marketing literature as

“income”), these are actually withdrawals of capital. As such, a life

tenant would have no entitlement to them unless, perhaps, the trust

gave the trus-tees power to advance capital to the life tenant. In

the absence of such a power, it might still be suitable for a bond to

form at least a part of the trustees&#39 overall inv-estment strategy –

the life tenant&#39s entitlement being catered for by other

incomeproducing assets. However, it is unlikely that the investment

of the whole trust fund into a bond could be argued to be suitable in

these circumstances.

Of greater interest to financial advisers is the new statutory duty

in section 5 for trustees to obtain proper advice before exercising

any power of investment. Not only that, section 4(2) imposes a duty

for trustees to review the trust investments “from time to time” and

proper advice must be obtained at the time of each review.

So, what is proper advice? This is defined in section 5(4) as: the

advice of a person who is reasonably believed by the trustee to be

qualified to give advice by his ability in and practical experience

of financial and other matters relating to the proposed investment

If a financial adviser does not fit this description, perhaps a

change of career should be considered.

Financial advisers are now placed in a privileged position. Trustees

are obliged by statute to obtain proper advice, not only when

exercising their power of investment but also at regular reviews, and

one of the best sources of such advice must be a duly authorised

financial adviser.

Having established a firm relationship with trustees, what investment

opportunities should be considered?

Assuming there is no need for income to be produced (unlike the

example of the life tenant trust above), a life insurance bond has

several attractions for trustees. One, for example, must be the ease

of administration associated with such contracts.

The need for diversification is clearly sensible. Financial advisers

were taught at their mother&#39s knee the perils of putting all of a

client&#39s investment eggs into one basket. However, the downside can

be that the more baskets you have, the more contracts you have to

review and administer. Would it not be helpful if trustees could

meet the need for diversification by investing in just one asset?

This is precisely what a with-profits bond can achieve.

A with-profits fund, by its very nature, is diversified. While

with-profits funds are traditionally invested largely in equities,

the exposure is generally lower than for unit-linked managed funds.

For a claim made when a “no market value reduction” guarantee

applies, smoothing also provides a cushion for the trustees – and,

hence, the beneficiaries – against the short-term volatility

associated with direct equity investment although, of course,

prolonged market falls will inevitably lead to lower payouts.

We are also at an interesting stage of with-profits evolution where

some funds have no exposure to equities. Instead, the underlying core

investments are made up of assets such as bonds and property. Such a

fund could still be classed as “diversified” (and in the current

stockmarket climate, may be attractive to trustees).

A further advantage is gained from the lack of any investment income

that would otherwise need to be declared under self-assessment.

Direct equity investment can result in receipt of dividend income by

the trustees which is taxed at the schedule F rate – 25 per cent for

trustees.

Distribution of this income to beneficiaries can result in the 34 per

cent rate applicable to trusts raising its ugly head, meaning further

administrative headaches and/or accountancy fees. Then the recipient

beneficiaries will have to reclaim overpaid tax or, if they are

higher-rate tax- payers, they will have further tax to pay. Contrast

this nightmare with investment in a bond, where administration of tax

liabilities will need to be considered only where a chargeable event

occurs and the advantages are plain to see. Add to this the ability

to minimise or eliminate any tax by changing the person(s) on whom

any liability will be assessed, and the choice of a with-profits bond

as a trust investment becomes a no-brainer.

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