Tax Advice on a Discretionary Trust

[Parky]

The interest in possession trust sounds interesting. I shall look at it closely when the book arrives.

I found the following useful :-
https://www.step.org/sites/default/file ... Trusts.pdf page 22 Appendix 1

and
https://www.tax.org.uk/policy-technical ... st-income-–-interest-possession-trust-–-trust-tax-return

[Gan020]

I've run all the numbers through a spreadsheet and it becomes clear that if I withdrew money from the Trust now, lived for another 30 years, paid the exit charge, allowed 1.25% for selling shares and buying them back within an ISA I would be far better off provided I don't die in the near future. This calculation holds true even if I pay 40% inheritance tax in my ISA which of course I can mitigate in later life by giving it away.

This is because I wouldn't be paying capital gains tax at 20%. Further if I don't adopt this strategy in later years I'm going to run into a problem with a tax pool on interest and dividends that just grows and grows.

Then I wondered if I can do the the same thing with my wife's SIPP. She is well below the LTA threshold. Does income from a Trust count as income for the purposes of pension contributions? What I mean is she currently contributes £2,880 which gets grossed up to £3,600 as she has no employment income. If the Trust did an income distribution of £6,500 which is £11,818 gross, can she contribute £11,818 into her SIPP instead of only £3,600?

[PinkDalek]

Does income from a Trust count as income for the purposes of pension contributions?

Most unlikely. Relevant earnings defined here https://www.gov.uk/hmrc-internal-manual ... 0#earnings

[Charlottesquare]

5. I read somewhere that the life of a discretionary trust is 80 years. It would be helpful to know
6. Is it normal that my father’s discretionary has powers to make distributions to anyone? (the text seems to say it is for the benefit of his offspring and their further offspring etc. but the trustees by agreement can choose to change this)

5. The Trust Period for the discretionary trust for which I am a Trustee is 125 years.

6. The Trustees have the power to appoint additional beneficiaries.


I gather that these are normal practice (date of deed was 2013).


I have similar concerns to the OP in many respects, albeit with much smaller sums involved. One thing I am seriously considering is to convert the Trust to an Interest in Possession trust, which can be done by a simple deed. All dividend income is taxed at 7.5% in this kind of trust. Furthermore, if the income is paid directly to beneficiaries it does not need to be declared on the Trust SA900 form.In fact, there is no need to submit an SA900 if there are no chargeable capital gains. The income has to be declared by the beneficiaries, but if they are non-taxpayers (grandchildren in my case), no tax at all is paid on the income (if they do not exceed their personal allowance). This avoids both tax and administration.


I have found the book Trusts and Estates, by Iris Wunschmann-Lyall and Chris Erwood, from the Core Tax Annuals invaluable in dealing with Trust matters. It is a dense read, and expensive, but covers most of your technical questions in detail, with example calculations. Cheap second-hand copies from previous years are usually available on Amazon. Mine from 2010/11 still seems more or less up-to date.


If you find a source of expertise in the West Midlands I would be interested to know - I am also in that area.

Parky.

The possible downside is the party entitled to the income may have the capital value of the trust, or part of the trust providing that income, as part of their estate for IHT purposes when they die- we have one of these currently running,arising from my late father's estate ,and I was also a trustee of a long standing one where the liferenter recently died. On the plus point that death washed out the latent CGT liability on the assets in question.

[hiriskpaul]

I've run all the numbers through a spreadsheet and it becomes clear that if I withdrew money from the Trust now, lived for another 30 years, paid the exit charge, allowed 1.25% for selling shares and buying them back within an ISA I would be far better off provided I don't die in the near future. This calculation holds true even if I pay 40% inheritance tax in my ISA which of course I can mitigate in later life by giving it away.

This is because I wouldn't be paying capital gains tax at 20%. Further if I don't adopt this strategy in later years I'm going to run into a problem with a tax pool on interest and dividends that just grows and grows.

Then I wondered if I can do the the same thing with my wife's SIPP. She is well below the LTA threshold. Does income from a Trust count as income for the purposes of pension contributions? What I mean is she currently contributes £2,880 which gets grossed up to £3,600 as she has no employment income. If the Trust did an income distribution of £6,500 which is £11,818 gross, can she contribute £11,818 into her SIPP instead of only £3,600?

This is a very interesting thread. I will order a copy of that book on Trusts and Estates.

On another thread I have been exploring the possibility of making interest free loans from a Trust. Have you looked into this as a possibility? The advantages are that the rate of growth of the trust would be reduced and the loan would not return interest to the trust. You and other beneficiaries could work the loans into ISAs and so generate tax free returns. When you and other beneficiaries die, the debt to the Trust would reduce the size of your estate. I am sure there must be pitfalls, but may be worthwhile thinking about, at least for part of the Trust.

[Gan020]

I said in an earlier post I would post again around June with my conclusions. Clearly it's taken far longer than I though.
I’ve visited an IFA (free first hour) but I’m not sure I’m comfortable with the advice I received as mostly the IFA seemed happy to repeat back to me my understanding of the situation and then at the end of the meeting talk about the investment returns they could offer which included a 8.87% fixed interest product (which made my head spin as I’m aware of the level of risk required for that sort of return).

Anyway I have concluded the following:
1. There would appear to be no reason I could not set up two new Trusts one in my name and one in my wife’s which would be more tax efficient than the current set up as it would give the benefit of 3x£325k IHT allowances plus 3X£6,000 CGT allowance instead of just one. This would of course mean that as settlors we couldn’t also be beneficiaries.
2. As personal tax rates for CGT are lower than the Trust rates for basic rate taxpayers it makes sense to pay the exit charge and hold the assets personally, subject of course to it then forms part of estate for IHT purposes.

My plan is therefore to reduce the value of assets in the Trust to around £800k (of which £100k is subject to BPR) over the course of the next 2 years by distributing to beneficiaries. Most of it will be invested personally by them but we are also going to spend some of it. I'm happy to leave that sort of value in there as it keeps it out of the beneficiaries estate and whilst there is on-going tax to pay that's the compromise I guess.

In about 5 years time I look re-look at setting up 2 new trusts funded from the £800k or so that will be in the Trust then. I may just give it away to my children instead, which to be honest in many ways seems much easier. I guess it will depend on our circumstances when we get there

Finally a QNUP (Qualifying non UK pension) has been suggested as a route to shelter the assets from IHT once removed from the Trust. I am still researching this.

[Parky]

I said in an earlier post I would post again around June with my conclusions. Clearly it's taken far longer than I though.
I’ve visited an IFA (free first hour) but I’m not sure I’m comfortable with the advice I received as mostly the IFA seemed happy to repeat back to me my understanding of the situation and then at the end of the meeting talk about the investment returns they could offer which included a 8.87% fixed interest product (which made my head spin as I’m aware of the level of risk required for that sort of return).

Anyway I have concluded the following:
1. There would appear to be no reason I could not set up two new Trusts one in my name and one in my wife’s which would be more tax efficient than the current set up as it would give the benefit of 3x£325k IHT allowances plus 3X£6,000 CGT allowance instead of just one. This would of course mean that as settlors we couldn’t also be beneficiaries.
2. As personal tax rates for CGT are lower than the Trust rates for basic rate taxpayers it makes sense to pay the exit charge and hold the assets personally, subject of course to it then forms part of estate for IHT purposes.

My plan is therefore to reduce the value of assets in the Trust to around £800k (of which £100k is subject to BPR) over the course of the next 2 years by distributing to beneficiaries. Most of it will be invested personally by them but we are also going to spend some of it. I'm happy to leave that sort of value in there as it keeps it out of the beneficiaries estate and whilst there is on-going tax to pay that's the compromise I guess.

In about 5 years time I look re-look at setting up 2 new trusts funded from the £800k or so that will be in the Trust then. I may just give it away to my children instead, which to be honest in many ways seems much easier. I guess it will depend on our circumstances when we get there

Finally a QNUP (Qualifying non UK pension) has been suggested as a route to shelter the assets from IHT once removed from the Trust. I am still researching this.

Gan020, Thanks for the update, you have clearly done a lot of research. Just a couple of minor comments:-
- I don't think there is any IHT benefit in transferring assets from one trust to another, as the assets will be subject to the 10 year IHT payment as if they were still in the first trust(IHTA 1984,s81 apparently). There would be IHT relief of course on any other assets you added, and of course the extra CGT benefits.
- As the widow/widower of a settlor you can be a beneficiary. Don't forget to add that to the list of beneficiaries of any new trust.

Good luck with your plan. I like the flexibility you have to adjust to changing circumstances.

[Howard]

I said in an earlier post I would post again around June with my conclusions. Clearly it's taken far longer than I though.
I’ve visited an IFA (free first hour) but I’m not sure I’m comfortable with the advice I received as mostly the IFA seemed happy to repeat back to me my understanding of the situation and then at the end of the meeting talk about the investment returns they could offer which included a 8.87% fixed interest product (which made my head spin as I’m aware of the level of risk required for that sort of return).

Gan

Thank you for updating the situation. A very interesting post.

It was helpful reading for me as I’m still considering how to provide some financial support to our grandchildren who are all under 12 at the moment.

Any comments by other posters on the practicalities of running a Discretionary Trust would be welcome. The key question: is it worth the hassle?

Following your initial post, I pursued the idea of setting up a discretionary trust with two wealth managers and, whilst they were both encouraging, their charges look very expensive to me as a “DIY” investor. Typically 1.5% to set up a trust and over 2% to manage it every year. Assuming it is designed to last around 15 years and will appreciate, the total charges overall in £ terms would be eye-watering!

A solicitor I consulted would set up a trust for around £1.7k incl vat and one of the stockbrokers I use would enable me to manage the investments for a similar modest cost to running an ISA or Sipp.

It would be relatively easy to select an investment portfolio aimed at capital growth but the issue which is making me wonder about this route is the tax reporting and administration, especially when making payments to the beneficiaries. The aim would be to provide capital sums to the grandchildren at age around 25. These would be fairly hefty amounts which could, for example, go towards a house-purchase.

The attraction of a trust is that it would involve our children as trustees and hopefully they would learn something about investing. But would they be be inclined to get involved in the admin, if Mrs H and I were gone?

The IHT tax avoidance benefits of a trust aren’t that attractive to me personally. And I was not keen on the advice of one of the advisors who advocated offshore investments. As an alternative to a trust, I could help the children and grandchildren with regular gifts out of income. These have been recorded on an IHT 403 basis for several years. Gifts to the children could easily be partly funnelled into junior ISAs or even pensions for grandchildren.

So the dilemma, hopefully relevant to your initial post outlining the admin problems for future generations in handling a trust is: are there better ways to help grandchildren than a discretionary trust?

Any comments by readers would be appreciated.

regards

Howard

[Kantwebefriends]

Suppose a Labour/LibDem coalition government takes office after the General Election. Suppose it pursues the idea of replacing IHT by a Lifetime Acquisitions Tax. The there must be a serious risk that distributions from a Discretionary Trust will be taxable according to the new laws.

I suspect that there is accordingly an incentive to distribute some capital from the trust now, before an emergency budget might impose a retrospective tax from, say, the date of the election. I suppose there's also a case for distributing all of it soonest if you are anyway tempted to do that long term.

P.S. Labour has form on retrospective taxation of inheritances: Healey in his Spring Budget of 1975 taxed "capital transfers" by virtue of deaths that had occurred over (approximately) the preceding year.

[Gan020]

- I don't think there is any IHT benefit in transferring assets from one trust to another, as the assets will be subject to the 10 year IHT payment as if they were still in the first trust(IHTA 1984,s81 apparently). There would be IHT relief of course on any other assets you added, and of course the extra CGT benefits.
- As the widow/widower of a settlor you can be a beneficiary. Don't forget to add that to the list of beneficiaries of any new trust.

S81 is as follows:
81(1) Where property which ceases to be comprised in one settlement becomes comprised in another then, unless in the meantime any person becomes beneficially entitled to the property (and not merely to an interest in possession in the property), it shall for the purposes of this Chapter be treated as remaining comprised in the first settlement.

I am in agreement that a transfer of assets from one trust into 2 new trusts would achieve nothing. It is therefore my plan to make distributions from my father’s Trust and pay the exit charges and therefore the property then belongs to the individual beneficiaries, who can then set up new Trusts. At least that is my understanding. In my particular situation I can get the first £250k out of my father’s trust with no CGT as there are a number of shares with capital losses and another number with small capital gains. Regrettably (from a tax point of view), the largest two holdings in the Trust have considerable capital gains and selling them would result in a considerable drop in dividends if re-invested in similar shares. These I will just leave in the Trust unless the share price gets so high I become a seller regardless of the tax consequences)
The widow/widower not being a beneficiary is one of the things putting my decision off for say 5 years as by then I will be 5 years older and more able to determine how much wealth can be irrevocably “given away”. I suspect in practice I will end up with some sort of phased approach.

Any comments by other posters on the practicalities of running a Discretionary Trust would be welcome. The key question: is it worth the hassle?

Following your initial post, I pursued the idea of setting up a discretionary trust with two wealth managers and, whilst they were both encouraging, their charges look very expensive to me as a “DIY” investor. Typically 1.5% to set up a trust and over 2% to manage it every year. Assuming it is designed to last around 15 years and will appreciate, the total charges overall in £ terms would be eye-watering!

A solicitor I consulted would set up a trust for around £1.7k incl vat and one of the stockbrokers I use would enable me to manage the investments for a similar modest cost to running an ISA or Sipp.

It would be relatively easy to select an investment portfolio aimed at capital growth but the issue which is making me wonder about this route is the tax reporting and administration, especially when making payments to the beneficiaries. The aim would be to provide capital sums to the grandchildren at age around 25. These would be fairly hefty amounts which could, for example, go towards a house-purchase.
Howard

There are no fees from HL for Trusts. But as with all brokers you will require an LEI at around £75 per annum

I am with you on the do it yourself approach to investing. As far as I could tell the IFA I saw took a percentage and then gave the money to 7IM (Seven Investment Management) who take a percentage who then invests in Investment Trusts (many of which are popular on TLF) who also take a percentage. If that's the route you want to take the top 10 holdings of 7IM are available for each of their funds, so you might as well do it yourself. (although noting do it yourself won't give you gearing which improves the IT's performance and you won't be actively managing the percentage in each trust on a daily basis)

I pay an accoutant to do the tax at £450 per annum which includes the tax return and the forms for the beneficiaries. The 10 year calculation is extra as are the forms for capital distributions. I have been offered cheaper quotes. I have also been offered a "full service" which covers all the admin and governance and tax returns for £750 per annum.

I pay an accountant as it helps me sleep at night but after 22 years I've learnt quite a lot and I'm considering doing it myself. Maybe that's a route you could take. Pay an accountant for the first 5 years and then review.

Finally returning to your question around is a discretionary trust worth it, I think my view is the following. If you trust your children and granchildren to be financial sensible and respectful of the money you are investing for them, then it would be far easier and probably more tax efficient to simply to give it away now and load up their ISAs/JISAs/LISAs. Of course at 18 the grandchildren can access the money and before then the parents could also plunder the grandchildren's accounts.

LISAs are best as they can only plunder them for a house purchase without giving up the 20% tax benefit and that's probably what you are giving them the money for anyway.

[scrumpyjack]

re giving it to the grandchildren as bare trusts, you do not need to make the parents the trustees of the bare trusts. It can be anyone including yourself. That protects the money until they are 18.

When they are 18 I think they probably have to be told of the existence of the bare trust and they can insist on the money being put in their name. However you do not need to put it in their name unless they insist. In our family that has often not happened for many many years, so leaving one obstacle in the way of them splurging it!

[mutantpoodle]

re reply by scrumpy jack

remember that even as children they will have a personal tax position...and an allowance of £11000+ as we all do
so you will need to make certain that they do not exceed that allowance with the interest from any bare trust that they might be unaware of

eg..their parents might also be handing over assets etc etc

[scrumpyjack]

Yes I have set up bare trusts for all my grandchildren and check with the parents about other income/gains of the children. All those personal allowances and CGT allowances really add up over the years! Certainly worth the risk that one of them might be financially unwise at 18.

Also it is best to keep the dividend income below £10,000 and gains within the allowance and proceeds not more than 4 x the allowance. That way no tax return needs to be submitted for the child.

On balance much much less hassle than any other sort of trust and far more tax efficient.

[mutantpoodle]

qq
On balance much much less hassle than any other sort of trust and far more tax efficient....uq

yes providing none of the 'children' go wild............the press is full of kids whose parents assure all that they are loving and caring kids etc etc etc

BUT......

imo a degree of control assures that YOUR kindness (and prudence) is not abused or wasted

[scrumpyjack]

I have many relations and friends where the children have been given / inherited money. In only one case did the child behave unwisely and that was well after age of 25!

Compared with the hassle, disagreements and high costs I have seen with other types of trusts, I know which I feel is the lower risk! But chacun a son gout!

The children will eventually have to take responsibility for their own lives and I think that is better than them becoming trustafarians and / or the family arguments that can arise with other types of trusts

[Chrysalis]

I agree with scrumpyjack, the tax treatment of discretionary trusts seems highly complex and also quite burdensome.

Of course the alternative to bare trusts is simply to wait until the beneficiaries are adults, or in need of funds, and simply gift it outright at that point.
I’m not sure why so many people seem to think that everyone else is a risk with money (I bet they’d consider themselves the exception to the rule!) Certainly I’ve benefited from gifts and inheritances. Have I ‘squandered’ the money? Perhaps, to some people, the travels as a student could be judged wasteful, or the purchase of my first proper camera, but not to me. I don’t think my fundamental attitude to money has been altered by being the recipient of occasional gifts, large and small.

[Gan020]

I'm not sure where to begin or end on the subject of trusting your children/grandchildren with what are substantial sums of money compared to their "income from traditional sources such as employment"

My perception is that they are probably intended for a lump sum towards a first house, university costs, maybe private school costs, maybe a first car, maybe to grant an opportunity to absorb culture and see other countries where this would not otherwise have been possible.

Speaking from personal experience my brother whilst using it for some of those things, has consistently used it to live significantly beyond his means. Over the years he's had about 20 times his annual salary after tax (he's not yet 50), from my parents either through the Trust or directly. He has nothing left in the Trust as he took out his "half" a few years ago.

He recently asked me if he could borrow some money. A few years ago my Mum was in tears "he can't afford to eat".

Did putting in it Trust make a difference? I'm not sure. Perhaps in our case the challenge was the assets were put in Trust for tax reasons and insufficient discussion was had around what the money in the Trust was for.

[scrumpyjack]

Yes, a fool and his money are soon parted. But it looks like in your brother's case, the use of trusts did not protect him anyway. I have seen this in my family that where some money was put in trust, so much pressure was applied to get it out that the trustee gave way and dissolved the trust. The money was not subsequently wasted but it does illustrate that trusts often do not achieve their objective and simply cause a lot of extra tax, expense and family discord.

As I said, I think the bare trust arrangement is much better.

[scrumpyjack]

ps in your brother's case, though it is hard, tough love may be for the best.

If he can't afford to eat, send him a food parcel, not more money to waste!

[eisman]

A couple of points:

It should be noted that undistributed income of a discretionary trust that has been retained for more than 5 years is now included with capital for the purpose of calculating inheritance tax 10 year anniversary charges arising on or after 6 April 2014. See HMRC manual IHTM42166.

Parky wrote:

One thing I am seriously considering is to convert the Trust to an Interest in Possession trust..

to which Charlottesquare replied:

The possible downside is the party entitled to the income may have the capital value of the trust, or part of the trust providing that income, as part of their estate for IHT purposes when they die.

Not so. Interest in possession trusts created after 22 March 2006 do not now form part of the estate of the life tenant for inheritance tax. They generally* fall (or, if created out of a discretionary trust, remain) within the relevant property regime and are therefore still subject to 10 year anniversary and exit charges.

* There are limited exceptions to this general rule:
- an immediate post-death interest (IPDI)
- a disabled person's trust
- a transitional serial interest