Trusts School Lesson 6 Q&A

Q. Loan Trust - if beneficiary is 40% or 45% taxpayer, and so pays those rates on chargeable gains, is the fact the loan trust growth saves 40% IHT negated by the tax the beneficiary pays on the chargeable gain?

A. This would not be my interpretation.

You must remember that the client would still need a tax wrapper, even if they weren’t using a loan trust. So if they were using an investment bond without a loan trust, they would be paying IHT at 40% on investment growth, and then their beneficiaries would also potentially be paying income tax on the chargeable gain.

Separately, with good planning it should be obtainable for the vast majority of bond gains to be extracted at basic-rate tax, or perhaps lower. Therefore, we think the number of people who will be paying 40% or 45% tax on bond gains will be quite small.

Q. Gift and Loan - If you give the "growth" to the beneficiaries do you gift segments or make a gift across all segments. If segments are gifted there will be less remaining and this will mean that the initial loan cannot be repaid from the 5% tax deferred. Is there a chargeable gain in the bond?

A. It needs to be looked at on a case by case basis. Options are for trustees to make a withdrawal across segments, fully encash segments or assign/appoint segments in favour of a beneficiary. Partial withdrawals to make use of the tax deferred allowance could be useful if the intention is to avoid triggering a gain. Whether you encash segments within the trust or assign to a beneficiary depends on the type of trust i.e. absolute or discretionary and the tax position of the parties involved. With an absolute trust any gain within the trust is probably going to be assessed on the beneficiary so assigning makes no difference. With a discretionary trust, gains could be assessed on the settlor if alive and UK resident in the tax year the gain arises whereas assignment would take advantage of the beneficiary’s tax position.

Q. Reversionary v gift trust = long term care concerns...

A. This is true, a reversionary trust does provide clients with some reassurance that they can access funds in the future if required.

Q. If a Will Trust sets up a Discretionary Trust with a tenants in common house in it. Allows the surviving unmarried partner to live there, but they aren't a named beneficiary of the Will Trust. Is the survivor a Life Tenant? Would they have access to income if the house is sold and funds invested?

A. This is a complex issue which highlights the difficulties of trying to use the family home as part of IHT planning. Definitely one for legal advice as the partner’s rights under housing law might be different from their rights under the trust. If the partner still owns half the house, it would be unlikely that the house could be sold without their consent.

Q. Who is liable to repay the outstanding loan on a loan trust if the value is lower than the original loan?

A. Life company loan trusts will usually have a shortfall clause. This means that if the value of the bond has fallen below the value of the loan due to fund performance, the trustees will not need to repay the full loan amount to the settlor.

However, if the loan cannot be repaid due to injudicious actions by the trustees, for example, advancing too much capital to the beneficiaries, then the trustees will usually be liable for any outstanding loan.

Q. For gift trust, you could die in less than 7 years - so gift may fail?

A. Yes, assuming the gift into trust is not exempt, if you die within 7 years the gift would fail. Failed gifts in the 7 years before death use up the deceased’s nil rate band in chronological order. Where they are covered by the nil rate band, no tax is due. Any gifts in excess of the nil rate band will be subject to IHT.

Q. Isn't a Loan Trust more reliable than a gift trust to work as expected/manage inherent risks? There's no 7 year clock and the periodic charges can be mitigated via Rysaffe

A. I don’t think a loan trust is necessarily in a different position to a gift trust when it comes to how likely it is to perform as expected.

I agree there is no 7 year clock because the outstanding loan remains in the settlor’s estate so I suppose if they changed this to 10 years for example, a gift trust could be impacted more than a loan trust.

While you can mitigate periodic charges for loan trusts, any changes to the periodic charge calculation would apply equally across discretionary loan and gift trusts.

Q. Assuming everyone is in agreement, what are the implications of collapsing a DGT and paying the fund to the beneficiary?

A. The settlor of a DGT can waive their right to future withdrawals but it’s not as simple as the trustees stopping the regular withdrawal instruction on the bond.

Generally the settlor(s) would need to give up their rights by deed and a solicitor might be required to draft the deed. Giving up their rights would also be deemed a further potential exempt transfer (PET) or chargeable lifetime transfer (CLT) if it’s an absolute or discretionary DGT respectively. To calculate the PET or CLT, underwriting and actuarial expertise will be required and this is likely to come at a cost, rather than a free service provided by the DGT provider.

The key point is to make sure you set withdrawals at a suitable level at outset or don’t do a DGT at all if they don’t need any withdrawals!

Q. Is the normal recommendation to set up an investment in trust to utilise NRB and RNRB before making outright gifts directly to children/grandchildren etc.

A. If setting up a discretionary trust and making an outright gift (a potentially exempt transfer) at around the same time there is a generally accepted order of gifting. You set the discretionary trust up first and then make your outright gifts. The reason for this is because the trusts nil rate band for periodic and exit charges is reduced by chargeable transfers in the 7 years before the trust is set up. While a successful PET will not reduce the trust’s nil rate band, a failed PET does. By making your PET after setting up the trust, even if the PET fails, there is no impact on the trust’s nil rate band.

You cannot use RNRB (or any inherited bands) with lifetime gifts.

Q. What are the main considerations when thinking about whether a joint DGT or 2 separate DGTs will be suitable for a married couple?

A. There are various considerations to take into account in deciding whether two single settlor DGTs are more appropriate than a joint DGT.

Where the DGT is set up on absolute basis the main thing to consider is whether you want the full amount of withdrawals to continue until second death or not. If you do want the withdrawals to remain at the same level a joint DGT would be more suitable as the withdrawals from the deceased spouse’s DGT would cease on their death.

If you are setting up a discretionary trust then you are likely to get a larger discount using a joint settlor arrangement as opposed to two single settlor trusts however, this should not be the deciding factor. Single settlor DGTs are likely to be more flexible because although withdrawals will cease on the settlor’s death, the surviving spouse is usually going to be a potential beneficiary of the deceased’s trust. This means that even though the “income” for the surviving spouse has reduced, they could still potentially top this up from the deceased’s trust if required (at the trustees’ discretion). This can be useful as expenditure will likely change when one of the couple dies so the withdrawal level that was appropriate when they are both alive, may not be after one of the couple has died.

Tax wise with a joint settlor DGT if you go beyond twenty years and one settlor is deceased there will be annual gains taxable at the trust rate.

Our general view is two single settlor trusts should be the default position unless you can think of a reason that they were not going to be troublesome.

Q. What about taking excess withdrawals from a pension to put into a gift trust? Does that work?

A. You can make withdrawals from your pension and gift this into a gift trust. If the pension income generated is surplus to expenditure requirements then the gifts may qualify under the normal expenditure out of income exemption. You would need to consider all the criteria that need to be met for the exemption so the gifts would need to be “normal” i.e. a pattern of gifting is established and the gifts should be similar in size.

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. If a client is a director of a Ltd company that holds a holiday home (for personal use) within the company then is this exempt from the IHT calculation? Also if he starts a whole of life policy can he pay this via his company account?

A. The client should always consult their accountant but it is likely that the holiday home would be treated as an excluded asset as it is not used for the purposes of the business. Any business relief given to the value of the shares in the limited company would be restricted to exclude the value of the holiday home.

The whole of life policy premiums could be funded from his company. Assuming that this is a personal policy, the premiums will be treated as a benefit in kind for the director and subject to income tax and Class 1 NICs. There would be no corporation tax relief for the company as this is not a trading expense.

Q. With an unquoted BR scheme my understanding is that after the 2yr qualification, you can make a gift of the holdings. These are a PET but if you die, the gift was exempt & so no IHT applies. It also means the asset is not in your estate for RNRB. This was confirmed by PUMA for their Heritage plan.

A. We definitely agree with the point about the RNRB. A gift of BR shares can restore an individual’s entitlement to the RNRB.

The other point about lifetime gifting is slightly more complicated, as the position on any failed IHT transfer (PET or CLT) will depend on whether the recipient who received the BR shares is still holding them.

So we disagree that the PET would always be exempt.

There may also be CGT to consider on the gifting of any BR shares.

Our main point on beneficiary access is if there is a requirement for beneficiaries to access for spending whilst the donor is alive then you will be in failed gift land.

Q. If you invest in BR and then gift/transfer the holdings into a trust (thereby reducing the estate for MRNRB purposes) would the IHT relief apply to the shares after 2 years, or not as they are no longer directly owned by an individual?

A. In this scenario, your client is deemed to be making a CLT. So the shares must be qualifying before placed in trust.

If they die within 7 years then whether business relief will apply to the CLT is dependent upon whether the trustees are still in ownership of the BR shares and the relief still exists.

If the trustees have disposed of the BR shares and no longer own them at the point in which the settlor dies, then the gift gets treated like a normal CLT.

Q. You keep on referring to the political/legislative risk to BR, what is to stop them changing Trust rules?

A. They could change trust rules however these changes are unlikely to be applied retrospectively. This means rule changes would have less of an impact on trusts set up other than maybe changes to periodic charge rates etc. With business relief, because the relief is only obtained on the owner’s death, any changes to the relief is more likely to have an impact on the planning.

Q. Leave it all to charity - simples!

A. Agreed. If the client wants to leave their estate to charity, IHT planning is no longer necessary and it’s just a question of advising on the clients existing arrangements and making sure they are appropriate.

Q. Penny – what’s funding the DGT

A. In the Penny case study the source of funds for the DGT was a beneficiary drawdown pot. The member died pre 75 so the drawdown pot is accessible tax free.

Q. Most examples are for clients with a lot of capital. How would this change for those with say an estate worth £8m but only £500k of that is liquid and the rest is tied up in the value of commercial / rental properties?

A. This is the type of scenario where taking out a Whole of Life policy can be particularly useful. If you don’t have capital to use towards your planning then if you can afford the premiums for WOL, you can at least arrange for the liability to be paid. Alternatively you could consider gifting properties either outright or into trust, or selling property to provide capital to plan with. These options will bring with them capital gains tax implications which need to be taken into account.

Q. Do you have anything that explains the solutions available that regain the RNRB?

A. The RNRB can be reduced or lost where the value of assets in the individual’s estate exceed the taper threshold of £2m. It is reduced by £1 for every £2 of assets in excess of the threshold so for someone who only has one RNRB available, it will be lost where assets reach £2.35m. Where a widow has inherited the unused RNRB of their deceased spouse or civil partner they will be lost when assets reach £2.7m. It’s important to remember that reliefs and exemptions are ignored when working out the value of the estate for the purposes of the taper so business relief and gifts to charity or a spouse are ignored. The way to reduce the value of the estate is to make gifts whether outright to an individual or a gift into trust. While gifts may take 7 years to fall out of the IHT calculation, for the purposes of the taper they reduce the estate value immediately. Basically, the only way to regain the RNRB is to reduce your estate.

Q. Are there any issues with payments to beneficiaries going through the settlor’s or trustee’s bank account if there is no trust bank account?

A. Ideally every trust would have a trustee bank account but in practice this doesn’t always happen. I think if you are going to use a trustee’s personal account, it needs to be very clear that the account is purely being used for administering the trust and money is moved out quickly. It would be sensible to open a separate account to make it clearer that there is no mixing of trust money with personal money.

Q. Client with 500k pension fund. If he buys an annuity with this amount does that mitigate potential IHT liability in any way?

A. Yes. If you purchased an annuity with your pension fund, your estate would immediately decrease in value. Assuming this is done in good health and not an attempt to confer a benefit on someone else the purchase in itself should not be an IHT event. Thereafter, Value Protection Lump Sums and Guarantee Periods payable on the first annuitant’s death are included in the estate.