Revocable Trusts, Living Trusts and Family Settlements
There are many trusts names / types that are frequently quoted to us by people who tell us that they have read about them on the Internet, in a newspaper article, heard about them from a friend in the pub or at the dinner table. Normally we are told that this is the latest idea for avoiding inheritance tax and that we should be recommending it to our clients. The three sorts of trust mentioned above are in fact different names for the same trust, which is a trans Atlantic import, and can also be found in such places as New Zealand and Australia.
The idea behind this sort of trust is that a person (the Settlor) puts his or her wealth into the trust; the Settlor is one of the controlling trustees and decides how trust property is used. Usually the trust is for the benefit of the Settlor and their family. The Settlor is also able to dictate what is to happen to the trust property after his or her death. This sort of trust is designed to keep the property out of probate and apparently also out of the net of tax. Such a scheme works extremely well in the USA and the Antipodes and there is a reason for this. Those countries either do not have a system of inheritance tax, or the threshold for the tax is set at such a high level that it rarely bites on the wealth of anybody except the extremely wealthy. Anybody who tries to create a trust of this sort in United Kingdom will get a very rude awakening. In the United Kingdom, creating this sort of trust is taking you into a tax car crash where you may be exposed to liabilities for each of inheritance tax and capital gains tax, all of which may, for good measure, be caped by an unwanted income tax liability.
Additional Types of Trusts
In addition to the above names, other names that we regularly hear are Wealth Preservation Trusts, Home Protection Trusts and more recently Bloodline Trusts.
Wealth Preservation trusts are most commonly insurance linked schemes, and can sometimes be extremely effective if your circumstances are suitable and we will often recommend that you seek specialist advice where we think that this sort of trust may be of assistance to you and your family.
Home Protection trusts are usually trusts designed to shelter your home from care fees. These are frequently marketed by so called experts who will frequently advertise on the Internet or in the local press, but are not always easy to track down after the event. The idea here is that you put your home into a trust and this is supposed to shelter it from exposure to care fees in your old age, whilst you can continue to live in the property or to benefit from the proceeds of its sale. In some circumstances, this sort of scheme can work, but it is a bit like the American trust referred to above – a high risk strategy which needs very careful advice. Many professionals are extremely reluctant to advise on these schemes because they are regarded as high risk and indeed any of the professional bodies involved with finance and trusts actually advise members not to ever touch such schemes.
Bloodline trust are just trusts which are designed to tie up your wealth for several generations and keep it out of the oppositions hands – the in laws!
Typically when dealing with Lawyers and Accountants or other professionals, specialising in tax the trust names mentioned above will never be heard. Instead you will hear a very limited number of trusts mentioned with the most common trusts that you will hear mentioned being either, Life Interest Trusts (LIT) or Discretionary Trusts (DS). Almost all trusts are one of these two types or variations of these; in particular you will sometimes hear a reference to a Handicapped or Vulnerable Persons Trust or alternatively to a Flexible Life Interest Trust (FLIT). It is also worth mentioning that the words Trust and Settlement are to all intents and purposes interchangeable. In this article we are using the word Trust, but the word Settlement could be used and there is no difference between the two.
A Life Interest Trust is a trust under which a person has a right to benefit from property during his or her lifetime. This can mean that you are entitled to occupy a house during your lifetime free of rent, or that money can be invested to generate an income for your benefit. The underlying house or investments comprised in such a trust does not belong to the person who benefits from it, and he or she does not, as a general rule ever have access to the underlying capital. On death, the Capital of the Trust will pass to other people. Trusts of this sort do pay inheritance tax but the way in which inheritance tax is paid is quite complicated and depends upon whether the trust was created during somebody’s lifetime or arose under a Will. These sorts of trusts are not generally used a great deal for tax planning and their principal aim is normally to protect the underlying value of the property for the next generation
Typically, Discretionary Trusts are notoriously difficult to understand. They provide that trust property is held for the benefit of a wide group of people and the trustees have discretion to decide who should benefit. Frequently when a Discretionary Trusts is set up, the person setting it up will give guidance to the trustees as to how he or she wants the trust used. It is very common to find that a discretionary trust which names perhaps 10 or 20 people as beneficiaries is actually only intended to benefit one or two of them unless something very unusual happens. This sort of trust has a tendency to be used quite widely as part of inheritance tax planning and they are also extremely useful for protection purposes if one of the beneficiaries has a rocky marriage or is well known for being incompetent with their money.
The nature of a Discretionary Trusts is much more flexible than an Life Interest Trust, which can provide many advantages, but at the same time it makes the management of these trusts much more complicated and frequently, professional assistance is needed when handling such a Trust. In addition to this, the sort of trust is always subject to inheritance tax on the creation and every 10 years. The rate of inheritance tax is a reduced rate and while it may well be worthwhile paying this tax, careful management is required to ensure that the trustees are not faced with cash flow problems.
If you are interested in discovering more about any of the above trusts and ways that they can be used to protect property or perhaps to assist in tax planning, Herrington Carmichael has a wealth of experience and you should contact a member of our private clients team to discuss your position.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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