Trusts School Lesson 5 Q&A

Q. So who exactly do you undertake the risk profile with

A. When advising trustees on making an investment, the personal attitude to risk of the trustees is irrelevant. The risk approach should be based on the objectives of the trust and timescale of the investment. If the trustees are investing for a minor, life tenant, remaindermen, a charity share or a mixed class of beneficiaries, the risk profile should reflect the fiduciary purpose of that part of the fund rather than the personal preference of the person appointing the adviser.

Q. Do the risk-profile issues relate equally to, say, the parents acting for their child's JISA?

A. The same discipline applies, but the legal relationship is different. With a JISA or a bare-trust-style child account, the money belongs beneficially to the child, not to the parent personally. The registered contact or parent is making decisions for the child’s benefit, so the risk assessment should focus on the child’s time horizon, the purpose of the funds, the inability to access JISA funds until 18, contribution pattern, capacity for loss and likely use at adulthood. It would be wrong to treat the parents’ own risk profile as automatically determinative. However, parents can provide the factual inputs and make practical decisions as the adults responsible for the account.

Q. Does a policy statement only apply to DFM's and not to a firm acting on a advised basis.

A. A policy statement is required by law where trustees are delegating their investment responsibilities. With a DFM investments are bought and sold without seeking approval from the trustees so they have delegated their investment powers. Where trustees are operating on an advised basis they have not delegated their decision making to a third party, they are just seeking advice. While it’s a good idea for trustees to produce a policy statement outlining the aims of the trust it is not legally required.

Q. Re case study 1, could Shona spend some or all of her father's trust fund for his two grandchildren before they are 18, e.g. on private education, or must Shona pay all pre-18 costs as the children's parent?

A. If Shona is a trustee, she must act under the trust deed and for the beneficiaries’ benefit, not simply as a parent looking to reduce her own expenditure. That said, applying income or capital for the beneficiary’s education could be viewed as applying the trust property for the benefit of the beneficiary.

Q. Might a GIA be an option where high income is needed from a bare trust (ie more than 5%) created on death of parents for minor children?

A. This could arise under a parents Will or on intestacy. If it was a Will trust you would need to check whether there were any investment restrictions in the Will (very unlikely). You could potentially use a Bond or an OEIC but you would need to think about how the trust was taxed. It sounds like this could potentially be a bereaved minor’s trust (can be created under parent’s Will or intestacy) or an 18-25 trust (created by parent’s Will). If this is the case it would be taxed as a discretionary trust as opposed to a bare trust so any income or chargeable gains if using a bond would be subject to trustee rate of tax. It may be possible to make a vulnerable persons election to reduce the trustee rates of tax to that of the beneficiary however, it would depend on exactly what type of trust had been created.

If it genuinely was a bare trust then normal planning rules apply when deciding on whether an OEIC or a bond is used. It depends on the available of allowances, amount of income and gains generated etc.

Q. For IIP trusts I generally select a portfolio of income generating funds with varying yields to generate natural income with the prospect of capital growth - with the natural income paid away either monthly, half-yearly or yearly to the life tenant - it generally works ok for me

A. That approach may work well for particular cases but I wouldn’t adopt it as a “one size fits all” solution. The trustees should be balancing the interests of the life tenant and remaindermen. The interests, needs and tax position of the beneficiaries will differ from one trust to another.

Q. Are there any issues with using a MPS, or is this the same as a DFM for the wording we need to look for?

A. Our understanding is that with a model portfolio service, the investment management is carried out for the portfolio as a whole so it is not a discretionary service. If this is the case then while it would be prudent for the trustees to create an investment policy statement it wouldn’t be legally required. The safest way to proceed would be to discuss the service being provided with the provider.

Q. Is a highly personalised bond in a trust a no no? Eg holding individual shares?

A. Normally the phrase ‘highly personalised bond’ is used to describe a bond that is subject to the Personal Portfolio Bond anti-avoidance legislation. This legislation took effect from tax year 2000/2001. Bonds that hold individual shares that the bond owner can select are subject to a deemed gain of 15% every policy year.  When this legislation came in, these products were withdrawn from the UK market. If you have a trust that is still holding one of these historic investments, it should be reviewed.

The only bonds that are currently sold to the UK market that can hold individual shares are run on a segregated or delegated basis. The bond owners cannot have any direct choice over what assets are chosen by the Discretionary Fund Manager that runs the investment strategy.  This means that the Personal Portfolio Bond legislation is not triggered.  Although the bond owners can supply their attitude to risk, investment horizon and broad investment aims. Whether this will be suitable as a trustee investment will depend on the trust and the funds available.

Q. If a % of the trust is allocated to a charity, what ATR/Risk would I use for the future charity beneficiary %?

A. The risk profile adopted for an investment should reflect the trust’s duties in relation to the charitable share and the trust’s terms, not the risk tolerance of anyone personally. If the charity has a fixed percentage entitlement, the trustees should consider whether that share can be separately identified for investment purposes and whether the investment horizon differs from other beneficiaries. Ultimately the trustees are going to have to decide what return they are trying to target for the charitable beneficiary and invest accordingly.

Q. Can you use the capital withdrawal element to withdraw funds to put into a Junior ISA each Year for a minor under 13?

A. Section 32 of the Trustee Act 1925 gives the power to trustees to advance capital to a minor beneficiary however, you should check the trust deed to see if there is anything which prohibits it. If the trustees advance capital to the beneficiary then it is no longer subject to the terms of the trust. Remember as well that with a JISA, the beneficiary will have full access from age 18, they can take over management of the JISA from age 16 and no access is allowed before age 18. These points need to be considered when determining whether a JISA is an appropriate option.

Q. Is it possible to assign a bond held in trust to an overseas beneficiary.

A. It may be possible legally and contractually, but it requires careful checks before any assignment. Overseas residence could cause additional provider due diligence, local tax, exchange control, reporting and policy-servicing issues. The assignee may be taxed differently on later encashment in their country of residence, and UK tax may still be relevant depending on the trustees, settlor, policy type and anti-avoidance rules. The practical answer is yes, but cross border tax advice should be sought prior to making the assignment.

Q. One of my clients has a daughter who lives in Mexico and they want her to be a trustee - you have said need to be careful with overseas trustees - what are the implications of having her as a trustee and should it be avoided? thanks

A. I don’t know what the implications are of having a Mexican trustee and I suppose that’s the point I was trying to make. Where you have an overseas settlor, trustee or beneficiary, unless you have access to someone who understands the cross border implications from a Mexican and UK point of view you don’t know what effect it would have on any recommendation being made.

Q. Is there a conflict of interest if an IFA acts as a trustee on a trust where they also act as adviser?

A. Yes. If you are paying for investment advice from yourself then there is a conflict of interest. That’s not to say you couldn’t act as trustee and adviser but you would need to keep very clear records in each of your roles.

If the adviser remains both trustee and adviser, the file should evidence that the arrangement is in the beneficiaries’ best interests, that costs are fair, that the trustees considered alternatives, and that conflicted individuals did not dominate decisions about their own remuneration.

Q. Could funds be used to fund JISA's ongoing for children as effectively a bare trust as funds locked away until 18?

A. Yes but there a couple of things to think about in determining whether its appropriate. Firstly, there is no access to a JISA before age 18 whereas with a bare trust the funds can be used to benefit the beneficiary. Also, although they can’t access the money until age 18, from age 16 the child can take over the management of the JISA which may not be what the client wants.

Q. Client who wants to invest money for her 3 grandchildren but allow access from age 25, but potentially for education before hand, do you have in house trust to cover this on a bare/Absolute basis?

A. A bare or absolute trust is normally the wrong structure if the client wants to prevent access until age 25. The core feature of a bare trust is absolute entitlement. The beneficiary is beneficially entitled to the capital and income from the outset, with trustees merely holding legal title. For most practical purposes, a beneficiary who reaches adulthood can call for the assets.  Where the intention is controlled access at 25 with flexibility to advance funds earlier for education you may want to consider a discretionary gift trust as a possible option. The trade-off is that a discretionary trust is normally a relevant property trust for IHT, with possible entry, ten-year and exit charges.

Q. Are Spousal-Bypass Trusts still available and effective for pensions, where client is on second marriage but wants spouse to receive an income but their own children to benefit on second death?

A. Spousal bypass trusts can still be an effective way of controlling who benefits from a pension death benefits.  The current starting point remains that pension scheme death benefits are governed by the scheme rules and member nominations/expression of wish, and any trust solution must be compatible with those rules and with current tax treatment e.g. not all schemes will allow payment to a trust. In a second marriage scenario, the intended outcome is often for the surviving spouse to have access or income while preserving ultimate benefit for the member’s children. That can be achieved by a bypass trust or a trust nominated to receive lump sum death benefits.

Q. In terms of the total return comparing collectives with bonds, no allowance for additional accounting expenses was included. In my experience, additional accounting fees can be more than the tax - even on offshore bonds. Just thought it would be worth mentioning

A. The tool should be treated as an investment and tax illustration rather than a full cost-of-administration model. If trustees hold collectives directly, annual tax administration can be significant, especially where there are accumulation units, offshore reporting funds, multiple income types, frequent switches, or disposals giving rise to CGT reporting. With regards to the accounting fees associated with offshore bonds, there shouldn’t be any tax accounting on behalf of the trust unless there is a chargeable event because the bond is a non-income producing investment. Even then, it would only be where the gain is assessed on the trustees which would require a tax return on behalf of he trust. In practice most chargeable gains are assessed on the settlor or beneficiary depending on whether the trust is discretionary, absolute or segments have been assigned/appointed prior to encashment.

Q. When using the comparison tool, there is no allowance for the additional cost of doing tax returns on a collective, especially if the portfolio is rebalanced periodically. Thoughts?

A. The tool should be treated as an investment and tax illustration rather than a full cost-of-administration model. If trustees hold collectives directly, annual tax administration can be significant, especially where there are accumulation units, offshore reporting funds, multiple income types, frequent switches, or disposals giving rise to CGT reporting.

Q. When dealing with an IIP can the trustees pay for the financial advice from trust funds? Are there any points for the FA to be aware of?

A. Trustees can normally pay proper expenses of trust administration from trust funds, provided the trust deed permits it. My understanding is that expenses for financial advice are not a deductible expense for tax purposes but advice should be sought on this point. If using an investment bond then ongoing advice charges are normally taken as a partial regular withdrawal so will use up part of the bonds tax deferred allowance and could potentially trigger a chargeable event where the tax deferred allowance is exceeded.

Q. What happens should all trustees die ?

A. Where a trustee dies they will automatically cease to be a trustee. If there are sufficient trustees remaining they will continue to administer the trust but it’s not uncommon to be left with no surviving trustees. Where the last trustee dies, their executor or the administrator of their estate will either take on the role of trustee themselves or appoint someone to act as trustee ensuring continuity for the trust.

Q. Can I confirm that the inclusion of an age target (.ie at 21) changes a bare will trust to discretionary even if the beneficiaries are named?

A. It is not the inclusion of a specified age that decides the classification. Its whether the beneficiary’s entitlement is vested and absolute or contingent/discretionary. 

For example, you may come across something in a Will leaves a legacy to grandchildren which states:

“for such of my grandchildren as shall survive me and in equal shares absolutely”

In the absence of any other conditions, this wording would create a bare trust. The only condition for the beneficiaries interest to vest is to be alive at the time of the testator’s death.

Where it gets trickier is when there are conditions attached as subtle differences in wording can make a significant difference. Take the following example.

“for such of my grandchildren as shall survive me and attain the age of 18 years”

In this example the beneficiaries interest doesn’t vest absolutely simply by surviving the testator. They also need to attain age 18 before they become absolutely entitled so this is not a bare trust and would be taxed as a discretionary trust.

This page in HMRC’s trusts, settlements and estates manual has some example which illustrate the difference.

TSEM1563 - Introduction to trusts: types of trust: bare or simple trust - HMRC internal manual - GOV.UK

Q. With bonds in trust, such as DGTs, you mentioned on a previous session that distributions would be classed as a return of capital within the 5% tax deferred allowance. For IIP/IPDI trusts, would this similarly be classed as return of capital to the life tenant? If so, would this go against the deed?

A. Any payments from a bond or assignment of segments to the life tenant would constitute a capital payment. If the trust deed didn’t provide the trustees with the power to advance capital to the life tenant then the trustees would be in breach of trust. There would also be tax implications as HMRC could treat the payment as income for tax purposes. That’s why its important to ascertain whether the trust gives the power to advance capital.

Q. If the bond is assigned and the settler is still alive, does that impact on tax on encashment

A. Generally, the assignment should have no impact on who is assessed on the gain however where a trust has been set up for a minor child of the settlor and the income (or chargeable event gain) exceeds £100 in a tax year, that income or bond gain, is assessed on the settlor. So, if you had a discretionary trust and settlor was the parent of the minor beneficiary having segments absolutely appointed to them (you would appoint rather than assign to a minor child), then the gain is likely to be assessed on the parent where the segments are encashed.

Q. For an IPDI and general investment account/OEIC, isn't it possible to mandate the income to the client removing the need for the trust to report on dividends/interest with the trust still reporting on CGT?

A. Yes, that’s correct. With an interest in possession trust it simplifies the administration if the trustees mandate the income directly to the beneficiary.

Q. Can you remind, what are the tax considerations if switching existing investment bond providers where the settlor is still alive?

A. There are various factors to consider depending on the specific scenario. You should always check the existing trust carefully to see if encashing the bond will have any unintended consequences but I’ve added some general points below.

Encashing a bond within a trust will give rise to chargeable event. Who is assessed on any chargeable gain depends on the type of trust involved. Generally, with bare trusts, the gain will be assessed on the beneficiary however where that beneficiary is a minor child of the settlor, the gain will be assessed on the settlor.  

Where the trust is interest in possession or discretionary, the gain is assessed on the settlor(s) of the trust if they are alive and UK resident in the tax year of the chargeable event. Top slicing relief is available as normal but if any tax is due then the settlor must reclaim this from the trust or they are making a gift for IHT purposes.

Be careful when encashing bonds when it comes to discounted gift trusts or reversionary interest trusts. Sometimes with these trusts encashing the existing bond can result in the settlors losing their right to withdrawals  reversions.