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Passing on wealth? Consider trust funds.

Trust funds - you’ve probably heard about them before. There’s always a fair share in your standard families-fighting-over-inheritance dramas and movies (Succession). More often than not, it is also used in a negative context or as a criticism - ‘He is a trust-fund baby’.

The reality is, a trust fund is simply a way of giving someone an asset (cash, a house, investments) without the donor giving up all the control to the recipient.

But why is it so important to create a trust fund? Not many people truly understand the benefits or structure of them.

Grandparents v.s. parents as donors

A common question we get asked is, “can I give this investment property/these shares to my 5-year-old?".

The simple answer is yes, but it may be different to a grandparent giving them to the 5-year-old. The advantages of each would also be very different too.

There is a specific rule called ‘parental settlement’. If a parent wants to give their child (under 18) shares of a company, any income that comes from this asset would still be taxable on the parent. Even though the shares would be in the child’s name, the tax would be deductible from the parent until the child turns 18. Once the child turns 18, the tax would be applied to them individually.

However, if the grandparent gave their grandchild any assets, they would not be liable to the applicable income tax.

The roles within a trust fund

Bear in mind these three roles of a trust fund before reading on:

  1. The settlor (the donor) - the person giving the assets that belong in the trust
  2. The trustee(s) - the person who runs the trust (typically also the settlor)
  3. The beneficiary (the recipient) - the person who is ultimately going to benefit from the trust

Herein lies the benefits of not directly handing over all your money to your newborn (grand)children.

1. It protects vulnerable people

It’s probably not a good idea to give a 10-year-old a significant sum of money (no matter how well-behaved they are).

A trust is a great way of passing wealth down the family line, without the worry that it will be squandered. The donor can maintain some control over the asset, as well as the income that the asset may produce. For example, if the trust had shares in it and there were dividends to be received, the recipient could be entitled to receive these too (if the donor wanted them to).

2. Tax advantages (not obvious at first)

There are different types of trusts and they are all taxed differently. Without looking at the whole picture, trusts can appear to be quite inefficient from a tax perspective.

However, the income tax that applies to the trust can typically be reclaimed by the beneficiaries. Without boring you, there are also Inheritance Tax and Capital Gains Tax advantages. Remember that each trust should be evaluated on a case-by-case basis, never assume that the tax conditions will ever be the same.

3. It guarantees who gets an asset

A trust can ensure that assets do not end up in the hands of an unintended person after a settlor has given them away.

A trust can protect assets from creditors or stop assets from being transferred outside the family circle in the case of a marriage breakdown.

4. It benefits employees/charities

Trusts can be used as a vehicle to provide benefits to employees or charities. Most people are already beneficiaries of trusts, and they don’t even know it!

For example, employment pensions are typically held ‘in trust’ for that individual. Employee shares schemes also typically have a ‘trust’ involved. Employers would be the trustees in this case and maintain control.

5. They encourage a certain type of behaviour/lifestyle

This aspect comes back to the ‘control’ element of trusts. A perfect example would be the ‘Grandchildren’s Discretionary Trust’.

The grandparents with lots of wealth decide to put an investment into a trust. The income from that investment is then intended to fund their grandchildren’s school or university fees. The grandparents would also potentially save Capital Gains Tax and Inheritance Tax personally.

If any grandchild decided not to go to university, then they wouldn’t necessarily be given any of the income from the trust. It is up to the ‘discretion’ of the individuals in charge of the trust. The donors essentially have the final say of what the money can and cannot be used for.

Getting support with trust funds

It’s tough to know whether a trust fund is the right financial decision for you not. We can help you decide if a trust is appropriate and explain what your tax and reporting responsibilities will be. To set up the trust, we would recommend a suitably qualified solicitor (if you do not already have one) that could create the trust deed. This would also help to ensure the consequences are appropriate for what you intend.

We also deal with the ongoing administration of the trust for our clients including:

  • Trust Tax Returns
  • The HMRC Trust Registration Service
  • Exit Charges and Principal Charges (Inheritance Tax)
  • Organising Tax Repayments for the beneficiaries (sometimes known as R40s)

Our expert tax advisor James Edwards is always happy to help answer any questions on trusts (and he loves a chat). Email us at Enable JavaScript to view protected content. or phone us on 0131 364 4191.

Please be advised that none of the above constitutes as formal advice and is to be used as general guidance only. If in doubt, please seek professional advice.

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