With respect to the current climate, scaling a global pandemic, and unrest in the political and financial markets, Trusts have been an ever-present concept. However, they are beginning to play a vital role in securing personal and business assets, especially given the plethora of issues we face globally today. A trust holds assets provided by a settlor, and managed by a trustee, for the enjoyment of a beneficiary. Trusts can be set up for numerous reasons, such as, to control and protect family assets, for beneficiaries if they are unable or incapable of handling their own affairs (e.g. children, people incapacitated or with disabilities) or to pass on assets while the settlor is still alive or when they pass away. Many assets, including cash, property, shares and land can be put in a trust to ensure that the person you want to receive these assets can fully benefit from them.
There are many types of trust, however the two I am going to focus on are an interest in possession trust (IIP) and a discretionary trust. An IIP is a trust in which at least one beneficiary has the right to receive the income generated by the trust or a right to enjoy the benefits of the trust for the present time in another way. This means that the settlor may place an asset into an IIP, the beneficiary, also known as the ‘life tenant’ has a right to enjoy the income generated from the asset but does not have a right to the asset itself.
Only later when the lifetime beneficiary is deceased do the trust assets transfer to the future beneficiaries, giving peace of mind to the settlor knowing their beneficiaries are going to receive what is rightfully theirs. IIPs are likely to arise where a settlor gives their partner access to the trust and be the ‘life tenant’ and then for the assets to pass to the settlor’s children once their partner dies. An IIP guarantees immediate income to the beneficiary, meaning that the trustees cannot allow any income to accumulate, they must pass any income generated immediately to the beneficiary, less any tax or trustee expenses. The robust protections offered by an IIP, along with favorable tax implications are the main reasons why many people choose to proceed with an IIP.
Furthermore, IIP trusts are flexible where they allow a beneficiary to benefit from the trust for a certain fixed period but can be subject to certain conditions set by the settlor and executed by the trustees, for example, revoking the trust if a partner remarries. The ease of the trust transferring to future beneficiaries highlights the wide range of benefits an IIP trust offers. There are a few downsides to an IIP, relating to the complexity and costs of maintaining a trust, however, these are broad and generally seen across many trusts, not just an IIP. Trusts can be complex to manage, and the complexity normally links to the amount of assets a settlor has and wishes to place into an IIP, although, with a proper structure to your estate, this can be mitigated.
A discretionary trust is a trust set up by a settlor, giving the trustees the ability to make certain decisions on when to distribute the income or capital, which beneficiary or beneficiaries receive what and how often payments are made. The settlor can also instruct the trustees to impose conditions on the beneficiaries; the most common example is withholding access to the trust until the beneficiary reaches a certain age. Discretionary trusts are frequently created for beneficiaries who are not capable of dealing with the finances themselves, or for a future purpose, for example, financial help for grandchildren or younger family members, who can benefit from the trust in later life.
Discretionary trusts offer a wide array of benefits, with flexibility arguably being the leading advantage. Trustees holding the power to decide when to allow beneficiaries access to the assets based on the terms of the trust may be vital for settlor’s when planning out their estate and allowing the trustee to fulfil the best wishes of the settlor when they may not be able to do it themselves. To continue, it grants trustees the ability to distribute assets in ways you may never have anticipated but benefit the person you intended.
The tax differences between both trusts must be addressed, as they are quite distinct. Both trusts require the trustees to pay any tax due on the trust unless the trustee ‘mandates’ income to the beneficiary, in which case the beneficiary must fill out a self-assessment form. For a discretionary trust, the first £1000 is taxed at a standard rate, and the remainder of the trust is taxed accordingly (Trusts and taxes: Trusts and Income Tax – GOV.UK ). If the settlor has more than one trust, then the standard rate band is divided by the number of trusts the settlor has, up to a maximum of 5, therefore the standard rate band would be £200. In the case of an IIP, the tax rate is fixed regardless of the assets held in the trust at 8.75% for dividend income or 20% for all other types of income. Considering the inheritance tax rate is 40%, setting up a trust can be very advantageous for your beneficiaries, who may save thousands on your estate from being due in tax.
Regardless of your purpose for setting up a trust, the protection offered by IIPs, and discretionary trusts are second to none, the relief settlors have knowing their estate and assets are safe for future generations is one of the critical reasons why many choose to create a trust, and why they are an essential ingredient to your estate plan, preserving your legacy and offering assistance to your loved ones.
For help and guidance, feel free to get in touch with Head of Private Client (Liverpool), John Paul Dennis on JPD@ProsperityLaw.com or give us a call on 0151 909 8657
This blog was written and prepared by Jack Donohue, University of Liverpool Undergraduate
