Should I form a trust?

What you need to know

Trusts can be a useful vehicle but are not for everyone.

They allow you to provide for your family while retaining some control. However, there are also disadvantages that should be considered. In this article we examine the main reasons why people create trusts and help you consider if a trust may be right for you.

Rothschild & Co does not provide tax or legal advice, but we can introduce you to lawyers and tax advisers who can help you create a trust and advise on its tax position.

What is a trust?

A trust is a simple concept, and you should not be deterred by any jargon surrounding it. In essence, a trust is an obligation.

The person who creates the trust (known as the ‘settlor’) transfers cash or property to other individuals or a company (known as the ‘trustees’). The trustees are obliged to hold the property they receive for the benefit of specified persons and/or charities (known as the ‘beneficiaries’). The identity of the beneficiaries is normally selected by the settlor and can, if required, be changed from time to time.

Most trusts are discretionary in nature. This means that the trustees retain discretion over the use and investment of the assets they hold in trust. So, the trustees can decide who gets what and when. You can normally be a trustee.

What are the benefits of trusts?

Individuals create trusts for a variety of reasons. Sometimes, the reason will be tax planning and we consider this aspect below. But often it is to enable them to give money away while retaining control over its use, or perhaps because they wish to provide for a vulnerable family member.

Flexibility is one of the main attractions of trusts. By creating a trust you can still retain a lot of control and have the ability to make decisions as the circumstances of family members change.

An example may assist in explaining how trusts can be useful.

John decides he wishes to provide for his grandchildren, but he does not want them to receive monies in their own names until they are older, when he can be comfortable that the monies will not deter the grandchildren from building their careers. John is therefore considering the creation of a trust for his grandchildren of which he will be the settlor and he and his wife will be trustees.

As trustees, John and his wife can decide when and how the monies are used – whether the trust funds be used to pay school fees, whether the trustees buy the grandchildren houses when they are older and so on. John therefore decides to book an appointment with his solicitor to explore more fully the possibility of creating a trust.

What are the downsides of a trust?

There are several potential downsides which you would need to consider before creating a trust. Normally you will not be able to benefit from the assets you place in trust, so you must be comfortable that you will never need the trust assets personally.

A trust also brings with it administrative costs, such as the need to prepare trust accounts, to register the trust and to file tax returns.

One of the main deterrents to the use of a trust is the inheritance tax (IHT) position. Subject to certain exceptions (which we outline below) you will pay IHT at 20% on the value of assets you place in trust (we refer to this below as the ‘20% IHT entry charge’).

This deters many people from creating a trust and instead they consider the use of a family investment company. However, there are several ways to create a trust without triggering this 20% IHT charge. If you can use one or more of these exceptions then you may want to consider a trust.

Does a trust have tax advantages?

Trusts can have tax advantages, although these have been reduced significantly in recent years. In broadest terms, a trust will pay capital gains tax and income tax like an individual and pay IHT every ten years, but only at a maximum rate of 6% (so trusts are often used as part of a succession and IHT planning strategy).

If you are domiciled outside the UK for tax purposes, an offshore trust can bring substantial tax saving opportunities and we can introduce you to specialist advisers who can help you understand these opportunities.

Creating a trust

If you are attracted by the flexibility of a trust, you may wish to consider if you can establish one while avoiding the 20% IHT entry charge. There are several ways you might do this:

• You can place £325,000 in the trust every seven years (as can your spouse if you are married) provided you have not otherwise used this IHT ‘nil-rate band’
• If you have disposable income (i.e. your income exceeds your expenditure) you can place the excess in the trust without an IHT charge. This is due to a relief known as the ‘normal expenditure out of income’ relief
• Certain assets are exempt from IHT, such as business assets (for example shares in an unquoted trading company) or agricultural land. These can often be placed in trust without an IHT charge. In many cases, it is also possible to place these assets in trust without triggering a capital gains tax charge and so these can be ideal assets to place in a trust

To continue the example above, after meeting with him, John’s solicitor suggests that he place some of the shares which John owns in his trading company, which is soon to be sold, in trust for his grandchildren. The solicitor explains that this can be done tax free, whereas if he sold the company and then placed the sale proceeds in trust, he would lose 20% in IHT.

John is attracted to this idea, especially when his solicitor said it’s a common technique for those selling a company and who want to provide a long-term vehicle to help their family.

The solicitor adds that many of his clients then invest the trust funds with Rothschild & Co so that the ‘pot’ grows. In time John could involve his grandchildren in the investment decisions so that they can become familiar with the use of money.

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