The Finance Act 2006, imposed the greatest alterations to the capital taxation of trusts since the mid 1970s, but Trusts are not “dead”. Although the tax position has changed for some trusts, Trusts are still useful for safeguarding the future of assets for the future.
The new situation in respect of trusts created by Wills is as follows:
- Discretionary trusts including family trusts utilising the Nil Rate allowance ie the threshold for Inheritance Tax (“IHT”) on the death of the first of a married couple to die – no change.
- Life Interest trusts – those that give an individual the use and enjoyment of assets for lifetime, or a shorter period, but protect the capital for stated ultimate beneficiaries (a format frequently used in the case of second marriages) and now renamed an Immediate Post Death Interest Trust or “IPDI” – no change.
The capital value is aggregated with the estate of the life beneficiary, at that beneficiary’s death. If the fund is not paid out directly to the next beneficiaries, when the life beneficiary’s interest ends (e.g. if the gift requires the ultimate beneficiaries attain a specified, future, age) then the fund will be subject to the new regime (see below) unless the replacement “trust” is for the spouse or civil partner of the original beneficiary, for the infant child of the person whose Will created the original trust or fulfils the requirements to qualify as a trust for a disabled person.
- Accumulation and Maintenance trusts (“A&M trusts”) for children under a specified age not exceeding 25 – have been popular as they gave the trustees a degree of flexibility over the payment of income and capital until the beneficiary was of an age to be financially mature. Such trusts no longer benefit from favourable tax treatment. Except in very limited cases, where the trust was created on the death of a parent and the child receives the capital at 18, such trusts fall into the new regime.Accumulation and Maintenance trusts (“A&M trusts”) for children under a specified age not exceeding 25 – have been popular as they gave the trustees a degree of flexibility over the payment of income and capital until the beneficiary was of an age to be financially mature. Such trusts no longer benefit from favourable tax treatment. Except in very limited cases, where the trust was created on the death of a parent and the child receives the capital at 18, such trusts fall into the new regime.
The New Regime
- Parents wishing to retain a qualifying age between 18 and 25 for their child’s inheritance can do so subject to the trust suffering an IHT charge of up to 4.2% when the capital is paid over (“an 18-25 trust”)
- Any other trust (not being an IPDI or trust for a disabled person-see above) created by a Will is subject to tax in a way similar to that previously applied to discretionary trusts. The fund is revalued on every 10th anniversary of the Testator’s death, with tax charged at 6% on any surplus value in excess of the then Nil Rate allowance (or a share of that allowance, if the Testator created other trusts). In addition, when capital is paid over to the eventual beneficiary, there is an exit charge of a proportion of another 6% charge depending on the time that has elapsed since the last 10th anniversary (or the creation of the trust, if it is less than 10 years old).
For many trusts this tax liability will never be an issue because the amount involved has to exceed the available Nil Rate allowance
Many grandparents consider that it would not be sensible for a grandchild to receive a substantial sum of money on his/her 18th birthday and that the possibility of a further charge to IHT (at 6% over a ten year period) is a risk worth taking to protect the capital beyond the beneficiary's 18th birthday. As there are now no tax advantages in grandparents using an A&M trust, provision for a grandchild can now be held in a standard discretionary trust. Such an arrangement would allow the Trustees to alter the beneficial entitlements to take account of beneficiaries’ individual circumstances and also to manage funds beyond a beneficiary's 25th birthday, if this is considered appropriate. Some parents may also favour the flexibility such a trust would provide.
What should you do?
Wills remain an important part of IHT planning. In particular, married couples or civil partners can make sure that they make full use of both available Nil Rate allowances by careful Will drafting.
It is important to keep your Will up to date, both in respect of your own and your beneficiaries’ circumstances and also as a result of changes to the taxation of trusts. It may be advantageous to consider replacing an A&M trust for beneficiaries at, or under, 25 with a fully flexible discretionary trust. This would allow the trustees to treat each beneficiary as appropriate for their needs/circumstances, rather than imposing a specified share and fixing the birthday on which the funds have to be paid over in full.
Settlements
It is important that Trustees look carefully at the provisions of every settlement (whether arising from a lifetime arrangement or on a death) to ascertain whether these changes will have an impact on the particular settlement and, if so, whether the trustees need to be taking any action. There are provisions for changes to be made to settlements, to avoid the impact of the new regime, so long as those changes are in place before 6th April 2008.