News Hub

What are the main advantages and disadvantages of creating a Trust for Private Wealth?

Industry news and our stories

In our previous article regarding trusts [see here], we explained what trusts for private wealth are, the most common types, how they are created and their key characteristics.  In this article, we wish to explain the main advantages and disadvantages of trusts voluntarily created for private wealth.

 

The main advantages

  • Protection of gifts to beneficiaries: trusts are often used by a settlor (the person who puts assets into a trust) to protect a gift to a beneficiary against the risk of unintended third parties potentially gaining access to it instead. Common examples are as follows:-
  • A parent wants to set their child up in life by making a large gift to them, such as a deposit for their first home, but is concerned about unfortunate events occurring in the child’s life after making the gift, such as divorce or bankruptcy. The parent could therefore make the gift into a trust from which the child could benefit, so that after the parent makes the gift, third parties involved with the child, such as the child’s spouse/Civil Partner or creditors, cannot gain access to the settlor’s gift, as it is owned by the trust rather than outright by the child personally.
  • Two spouses/Civil Partners, one perhaps younger than the other and/or each having children from previous relationships, each own a share (usually equal) of the equity in their residence. They both want to ensure that their individual share passes to the beneficiaries of their Wills (i.e. their respective children) after their respective deaths.  In such a scenario, the surviving spouse/Civil Partner would be given the right to reside in the property after the first death until their later death (which creates a trust in the Will of the first to die), at which time the respective shares of equity in the residence would pass to the beneficiaries of the respective Wills.  Were the surviving spouse/Civil Partner to simply be given the share of the first to die outright with no conditions in the Will, the survivor could hypothetically gift the entire equity in the property (therefore including the share of the first to die) to a hypothetical new partner/spouse/Civil Partner by Will or otherwise and/or only to the beneficiaries of their own Will, which therefore may not include the children of the first to die.
  • Estate planning: creating trusts can be a useful tool for a settlor to ensure that the persons they wish to benefit during their lifetime and after death, can do so in the proportions that the settlor wishes and in a tax-efficient manner.

A common example would be a settlor who owns a second home (not their main residence), which they wish to gift in their lifetime to a particular beneficiary (e.g. one of their children) or class of beneficiaries (e.g. all of their children, perhaps in different amounts), for the purposes of supporting the beneficiary/beneficiaries immediately, rather than only after the settlor’s death and to also potentially reduce Inheritance Tax (‘IHT’) on the settlor’s estate.  The settlor could simply make an outright gift of the property, however, depending upon how much the property had gained in value since the settlor acquired it, the gift may trigger a liability to Capital Gains Tax (‘CGT’), which the settlor would be liable to pay, despite having given the property away and therefore not having enough money to pay the CGT.  A common strategy for the settlor to avoid personal liability for payment of the CGT would be for them to gift the property into a discretionary trust created by the settlor, of which the persons who the settlor wishes to benefit would be beneficiaries.  If the property is less than the settlor’s tax-free amount for IHT, no IHT would be payable on the gift of the property into the trust and the settlor’s tax-free amount for IHT would be unaffected by the gift if the settlor survived seven years from making the gift, which could therefore reduce IHT on their death.  The terms of the trust could also be used by the trustees (one of which could be the settlor) to determine which beneficiaries within the class of beneficiaries should receive the benefit of the property and in what proportions, which would allow the settlor to react to changes in the life circumstances of the beneficiaries from time to time (e.g. they may have a child wealthier or otherwise less in need than that of another child).

  • The settlor can retain some control as to how the assets gifted to the trust are used: a settlor can make themselves a trustee of a trust that they create. As trustees must act jointly and therefore unanimously, provided that the settlor does not act in any breach of trust and/or to thwart the intentions for which the trust was created, the settlor has an equal say in how assets within the trust are managed and distributed to beneficiaries.

 

The main disadvantages

  • The settlor cannot take the assets back: after the settlor has gifted assets to the trustees of a trust, they usually cannot take them back. If they do, the trust must have been created as a ‘settlor-interested-trust’, which has severely disadvantageous tax consequences.
  • Taxation: trusts can be subjected to significant taxation from creation to winding-up. For example, gifts to trusts of assets valued at more than the tax-free amount for IHT at the time of the gift are subject to half of the death rate for IHT (the full rate is currently 40%) and the full death rate becomes payable if the settlor then dies within 7 years (subject to ‘Taper Relief’).  Certain types of trusts are taxable to IHT every 10 years from creation.  CGT liability can also arise if assets to which it applies (most commonly land, shareholdings and property) are gifted to a trust and could become payable (subject to Reliefs) as well as IHT, unless it is capable of being deferred.  Trustees must also pay the top rates of Income Tax, CGT and Stamp Duty Land Tax from time to time.
  • Compliance obligations: in recent years, legislation has introduced the ‘Trust Registration Service’, according to which a trust that is not within a very limited category of trusts must be registered with HMRC. The process is time consuming and could be complex to someone unfamiliar with the laws relating to trusts.  Some types of trusts also have to prepare and file an annual ‘Trust and Estate Tax Return’ and in certain circumstances, an ‘IHT100’ when assets leave trusts.

 

Conclusion

It is crucial to seek professional advice to understand whether the potential advantages would be likely to outweigh the potential disadvantages of creating a trust for private wealth and which are very specific to each matter.  Please contact us to receive a client-tailored service to assess and achieve your objectives.

 

Article written by Stephen Roberts – Private Client Solicitor at Edmondson Hall Solicitors.

If you would like further information or to book an appointment, please contact us on 01638 560556 and speak to our experienced Private Client team.

 

Alternatively, you can email clare.bursford@edmondsonhall.com

Related Stories

29 May

What are the main advantages and disadvantages of creating a Trust for Private Wealth?

19 Apr
/ by Andreea

Edmondson Hall Charity 5-a-side Football Tournament & Family Fun Day 2024

26 Mar

Are you registered?

6 Mar
/ by Andreea

East Anglian Air Ambulance – Together We Step 2024 Challenge

Stay up to date

Follow us.