Trust Briefing Note May 2007

Benefits of a Trust

Trusts have traditionally been used as a tool in succession planning to avoid death duties. A private trust is most typically employed in the present era to detach property or assets from a wealthy estate owner so that his or her estate is reduced with the consequence that the extent of inheritance tax on eventual death is reduced. The distinct benefits of employing a trust, as opposed to the direct transmission of property to beneficiaries, can be summarised, as follows:

  • fiduciary control over assets and voting rights
  • benefiting the younger generation without exposing assets to ‘youthful folly’
  • income tax benefits for adult children
  • income tax benefits for infants where the settlor is not a parent and the money effectively belongs to the child (often referred to as a ‘bare trust’)
  • some measure of protection from creditors and estranged spouses

Possible disadvantages of trusts

The key issue for a potential settlor who is concerned with inheritance tax mitigation is, can he or she afford it? You should be sure that you have sufficient assets and pension funding to sustain your lifestyle, bearing in mind increasing life expectancy and the financial impact that low interest rates or continuing inflation may have.

Once you are satisfied with this fundamental issue, trusts can be tax efficient in a number of ways although all trusts (except bare trusts – see below) are liable to the top rate of capital gains tax (‘CGT’) which is 40%. Discretionary and Accumulation and Maintenance settlements pay income tax at 40%.

Examples of trusts

Different types of trusts are illustrated below by reference to the tax benefits usually associated with them. It should be noted that the different trusts described below are not mutually exclusive. In other words, it is feasible and often desirable for one trust to be, in sequence, a discretionary trust, changed to an accumulation and maintenance trust, then an interest in possession trust and finally a ‘bare trust’ by reason of the trustees exercising a given power of appointment over income and capital.

Discretionary trusts

In this instance, the trustees hold the income and capital for a class of beneficiaries, where no one of them has a vested right to income or capital. It follows that none of them have an interest in possession in this type of trust.

So far as the settlor is concerned, a discretionary trust gives complete flexibility, which is very attractive. An important tax benefit is that no beneficiary is liable to capital taxation in respect of his or her own death.

If property not qualifying for any IHT reliefs is given to a discretionary trust, it is an immediately chargeable transfer and if the historical and present total of chargeable transfers made by the settlor exceed £300,000, IHT is chargeable at 20% on the excess. There is a ten-yearly charge on capital within a discretionary trust, but the rate of tax does not exceed 6% on these occasions. Finally, there is an ‘exit charge’ on property leaving a discretionary trust when paid to a beneficiary, or where the discretionary trust is terminated and the trust becomes a different type of trust.

The settlor can hold over the capital gain on gifts into trust providing that neither he nor any of his infant children can have any possible benefit from the trust at any time

Accumulation and Maintenance trusts

These are discretionary or income accumulation trusts set up for infants and beneficiaries under the age of 25 years under which the beneficiaries will become entitled to an interest in the trust capital (either absolutely or as an interest in possession) at an age not exceeding 25. In the interim the income must be accumulated except for that applied for the education, maintenance and benefit of the beneficiary.

New accumulation and maintenance trusts are now subject to the inheritance tax charges outlined above. There are transitional rules for existing trusts. The restriction on hold-over relief for settlor-interested trusts also applies.

Interest in possession trusts

In the past a gift to an interest in possession trust was a PET for inheritance tax. If the settlor survived any gift to the trust by seven years, there was no IHT by reference to his or her estate. However, such a trust is liable to IHT on the death of the person with an interest in possession. If there is a termination of that interest, e.g. by advancing capital to reversionary beneficiaries, there is a PET exposure on the trust for seven years after the termination.

With effect from 22 March 2006 new interest in possession trusts are subject to the inheritance tax charges and hold-over restrictions outlined above.

The reason that clients use trusts such as these is to ensure that the benefit of their assets will go to predetermined beneficiaries. For example, a trust will often provide an interest in possession for the settlor’s spouse, giving him or her an income interest throughout their lifetime. On the death of the life tenant, the capital will go equally to the settlor’s children; perhaps employing an intervening accumulation and maintenance trust if a child is under the age of 25 at the death of the life tenant.

Bare trusts

This is the simplest form of trust, in which a trustee holds property absolutely for a beneficiary. Bare trusts are often employed to hold property for infants. However, any income that arises to an infant under 18 years of age is assessable to income tax on the parent, if he or she provided the capital of the trust.

For capital gains tax purposes, the acts of the trustee are regarded, in capital gains tax terms, as the act of the beneficiary. Where a 40% taxpayer is contemplating a company sale, it is therefore useful to consider creating bare trusts for relatives and children so that each absolute beneficiary is entitled to the annual exemption of £9,200 and, beyond, the marginal rates of tax of 10% and 20% can be secured.


Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed merely to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.

Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.