The diminishing use of trusts: Are trusts still useful?
08 October 2019
08 October 2019
According to the latest HMRC statistics the total number of trusts and estates registered for self-assessment fell by 6% to 149,000 in 2017-2018, continuing the downward trend that has seen the numbers fall by almost 30% since 2005.
Should trust practitioners be concerned? Are the attractions and benefits of trusts no longer valid?
Well, you know what they say about statistics. Needless to say, the number of trusts registered for self-assessment represents only a proportion of all trusts. Trusts which do not need to self-assess because, for example, they do not receive any taxable income and have no taxable gains (including all those invested in life assurance bonds and without any chargeable event gain to report) will not be included. Neither will be the interest in possession trusts where all income is mandated to the income beneficiary and, of course no bare trusts need to self-assess.
It is noted that the Trust Registration Service had 107,5000 registrations as of 5 March 2019, an increase of 22,500 on the previous year. This number is, of course, expected to increase sharply in January 2020, when it becomes mandatory to register all trusts, regardless of whether or not they have tax consequences. So, the statistics for the period after that date will be far more significant.
Statistics aside, clearly there have been developments, particularly since 2006, which have impacted negatively on the use of trusts.
The introduction of the relevant property regime for most lifetime trusts from 22 March 2006, the new rules on same-day additions to settlements, strengthening of the anti-avoidance rules for offshore trusts and non-domiciled settlors and, of course, the introduction of the Trust Registration Service, all contributed to certain slowing down of trust business. Extension of the DOTAS regime to inheritance tax has also made it more difficult to design new trust-based strategies for tax mitigation.
On the other hand…
You could say that all the furore about the changes to trust taxation since 2006 made advisers and clients alike more trust-aware. More life offices, especially those offering protection policies, have embarked on making trusts easier by offering online completion. And while some aspects of discretionary trusts are more complex to explain (and understand), for those comfortably within the nil rate band for IHT, in some respects being able to dispense with having to explain the importance of the beneficiary’s right to trust income when dealing with a life policy has made the choices easier.
So, by way of a quick review, let’s run through the most common types of trust and their benefits.
Discretionary trusts, pilot trusts and A&M trusts
(i) Discretionary trusts
For lifetime trusts, fully discretionary trusts seem to be the most popular choice nowadays for those who can make gifts covered by an IHT exemption(s) or falling within the IHT nil rate band.
Of course, there is the dreaded “IHT relevant property regime” with its periodic charges and exit charges but, when the initial gift does not result in an entry charge, these charges will frequently also be avoided.
The one issue that seems to have caused problems, at least for some, is the requirement to have the default beneficiaries named or defined under the trust. This requirement stems from the need for certainty of the beneficiaries which is one of the requirements for a valid trust to exist. It must be clear and certain at any time who the beneficiaries are under a trust. If the choice is simply left to the trustees then, unless the trustees actually appoint someone, that certainty will be lacking. It seems to be straightforward enough but apparently (judging by a number of queries related to this that arrive at Technical Connection) some people believe that if they “put some names” in the box designated “Default Beneficiaries” (which is the usual provision in most of the draft discretionary trusts provided by life offices and investment companies), it will mean that those named individuals will benefit under the trust.
Of course, under a discretionary trust such default beneficiaries will only benefit if there is no other appointment made by the end of the trust period (usually 125 years) and this should be obvious if one reads the trust provisions, but apparently it is not always so. It must be said that the default beneficiaries do not necessarily have to be named as particular individuals although this is the simplest way of dealing with the question of certainty. It should be possible to define the default beneficiaries in some other way, but great care needs to be taken to ensure that the result is certain, for example that there is no need for anyone to still have to exercise their discretion over the choice. In practice, you would not expect a trust to actually last 125 years without the trustees making an appointment of benefits but, if there is no certain default beneficiary, there will be a possibility of a “resulting trust” for the settlor. Whilst HMRC has confirmed that this by itself will not amount to a gift with reservation of benefit (thus negating any IHT benefits of the trust), there will be income tax implications including a potential POAT charge.
(ii) Pilot trusts
A separate mention needs to be made of discretionary “pilot trusts”. These are trusts set up with a small sum, usually £10, as a receptacle to receive larger sums in due course, usually following the death of the settlor. Trusts created on different days are not related settlements for IHT purposes so the benefit of such an arrangement is that each trust will be entitled to its own nil rate band for IHT purposes. Following the introduction of the anti-avoidance rules on “same-day additions”, such planning no longer works for additions on death. However, settling several trusts on different days (in accordance with the so called “Rysaffe” principle) still works very well with life policy trusts involving protection policies where the premiums paid by the settlor are covered by IHT exemptions, and with Loan trusts (see below).
(iii) A&M trusts
Finally, remember that not all trusts falling within the relevant property regime will be fully discretionary trusts. Most lifetime trusts, i.e. trusts other that trusts for the disabled and absolute trusts, will also be subject to this regime. This includes trusts with an interest in possession (see below re flexible trusts) and many trusts for children or grandchildren which take the form of what used to be called an “accumulation and maintenance” trust, for example a trust under which a minor child becomes entitled at age 25 or 30 and until then the trustees have discretion whether to use the trust income for the child’s benefit or accumulate it. Many settlors (and testators) still prefer this form of trust for specific beneficiaries rather than a fully discretionary trust.
As far as will planning generally is concerned, with the introduction of the IHT transferable nil rate band there is no longer a need for the spouses to ensure they use their respective nil rate bands on the first death. But this does not mean that discretionary trusts have disappeared from will planning altogether; there may still be valid practical reasons to use a discretionary trust. On the other hand, if the only reason that a couple have included nil rate band discretionary trusts in their pre9 October 2007 wills was to “bank” the nil rate band, and especially where the nil rate band legacy was to be satisfied by an IOU or a charge on the couple’s home passing to the survivor, well then they definitely need to review their wills and consider making new ones.
Inheritance trusts using life assurance bonds
The two most popular IHT mitigation schemes (also sometimes called “inheritance trusts”) available from life offices are the Loan Trust (or Gift and Loan Trust) and a Discounted Gift Trust. Following the extension of the DOTAS rules to inheritance tax there was concern about such schemes, so it came as great relief that HMRC confirmed that it considers these schemes as legitimate planning. In effect, HMRC seems to have accepted that life assurance bonds have a “special” place in taxation, not just as far as the taxation of chargeable event gains is concerned, but in tax planning generally. It is important to remember though that this favoured treatment applies to the existing tried and tested plans. It will not necessarily apply to any new trust arrangements offered by a life office.
Trusts which don’t count as relevant property include the following:
- bare (absolute) trusts;
- interest in possession trusts with assets that were settled before 22 March 2006;
- an immediate post-death interest (IPDI) trust;
- a transitional serial interest (TSI) trust;
- a disabled person's interest trust;
- a trust for a bereaved minor (TBM); and
- an age 18 – to - 25 trust.
Some of these must have been created before 22 March 2006 (such as the TSIs) and others may only be created on death (such as an IPDI, TBM or an 18 to- 25 trust). This aspect will therefore be relevant to will planning. It should go without saying that if there are potential minor children or grandchildren beneficiaries who will benefit on death, it is always best to include all the appropriate trust provisions in a will. If there are no such express provisions a trust will nevertheless come into effect as long as the beneficiary is a minor and there is not an absolute entitlement but someone (usually the executors or their adviser) will have to figure out what kind of trust is it (this will depend on the precise wording of the will). Deciphering will trust provisions to establish the type of trust in question before the trustees can invest the inherited funds is one of the most common enquiries we receive at Technical Connection.
Lifetime flexible trusts
Although the IHT advantages of using a flexible trust as compared to a discretionary trust have disappeared for post 21 March 2006 trusts, flexible interest in possession trusts are still useful from an income tax standpoint.
This is because income arising under an interest in possession trust will belong to and be taxed on the beneficiary entitled to it. Therefore, the need for trustees to pay income tax at the high trustees’ rates and the administration that goes with this is avoided. Instead the trustees:
- are liable for basic rate tax but only on the income they actually receive, and
- the beneficiary entitled will be subject to any income tax at their marginal rate(s).
Indeed, if all the trust income is mandated (paid by the provider straight to) the income beneficiary, the trustees will have no tax liability at all and no need to file tax returns.
There are two situations where trust income will not be taxed on the beneficiary.
- Where the trust is settlor-interested (i.e. the settlor or settlor’s spouse can benefit). Here trust income is taxed on the settlor.
- Where the settlor is the parent of a beneficiary, who is their minor unmarried child not in a civil partnership, and the income entitlement of the beneficiary (from all gifts provided by the same parent) is more than £100 in a tax year. Here income will be taxed on the parental settlor.
Remember that to achieve the above income tax treatment the trust investments must be incomeunit trusts or OEICs. Insurance bonds and accumulation unit trusts or OEICs will not be suitable.
Given the above I believe we can safely conclude that trusts are here to stay. Then again… The current Chancellor of the Exchequer Sajid Javid (correct at the time of writing) has just announced his intention to abolish inheritance tax. To be honest this is probably unlikely to happen any time soon but, if it were to happen, we will just need to get back to the practical - as opposed the tax- benefits of trusts.
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.