Julie Hutchison, head of estate planning at Standard Life, explains how to make the most effective use of family trusts.

Families have used trusts as a means for holding and passing on wealth for generations, but what exactly is a trust? How can trusts help with estate planning and what are the various types of trust available? This article will help to demystify some of these aspects, in particular looking at how trusts are used with insurance policies, bearing in mind that tax and legislation are liable to change, so that the relevant tax rates and reliefs may be altered in the future.

According to figures compiled by HM Revenue and Customs, between 1960 and 2002 approximately £37 billion was gifted to trusts in the UK. This shows just how embedded trusts are in this country as a route for controlling how property is transferred within families.

Understanding the basics
A trust allows property to be gifted by someone (the settlor), to be held and owned by a group of people (the trustees) and applied for the benefit of another group of people (the beneficiaries). Within a family, people can wear more than one hat in this arrangement. For example, a grandmother who sets up a trust can be both the settlor and a trustee.

Trusts are used both for lifetime estate planning as well as in wills. The motivation remains the same, however, since asset protection is the key benefit with a trust.

The inheritance tax (IHT) benefits of using certain types of trust are a factor for some people (see overleaf) but the primary advantage lies in the protective benefits.

The family scenario here could involve young children who cannot deal with money yet, or the teenager about to go to college or start a gap year. Alternatively, an individual might have special needs and be unable to ever deal with money, or have an addiction that the gift or inheritance would otherwise fund if access were not controlled. All these elements of family life prompt the desire to protect individuals by putting mechanisms in place for controlled access to property.

Planning ahead
There could also be issues about keeping assets within the family in the event of death, divorce and remarriage. For example, X and Y marry and have children. Y dies and X marries Z and has further children. The children from the first marriage can be protected from disinheritance by using a will trust. This means that X can benefit from the trust that holds the assets of Y, but the trust property is then passed back to the children of the first marriage and not passed to Z and the new children, since they are not beneficiaries of the trust. This is a common form of will trust.

Trusts are also frequently used to hold insurance policies. This brings a number of benefits. Firstly, when someone dies, it can take six months or so for probate (or ‘confirmation’ in Scotland) to be granted. This is the document that formally gives title to the executors of the deceased person. With that paperwork, the executors can then deal with the estate.

An insurance company will pay the proceeds of a life policy to the executors on production of the probate paperwork. If, however, the policy were in trust, there would be no need to wait several months for probate to be granted, and the trustees could claim on the policy shortly after the person had died. This brings cash flow benefits for the family.

The second benefit here is that IHT at 40 per cent could be saved on the proceeds of
the life policy, if the estate would have been taxable. Speed of access and reducing IHT are two good reasons why a trust can work well with a life insurance policy.

Making the right choice
When it comes to the specific type of trust that works best for you and your family, there are various choices. Much depends on whether you want to fix the beneficiaries at the outset or whether some flexibility is needed. Flexibility is often preferred, since future children and grandchildren can be accommodated. Equally, there are sometimes good reasons to fix the beneficiaries.

The main choices are:
• a bare trust (where the beneficiaries are fixed and, generally, the beneficiaries can access funds at age 18)

• an interest in possession trust (where certain beneficiaries have a right to income, and there is a second person or group of people named who receive the capital)

• a discretionary trust (where, as the name suggests, there is maximum flexibility to choose who gets what and when).

In terms of IHT, after making a gift and living for seven years, it falls out of your estate. Any growth in the trust’s assets from the date you make the gift is also out of your estate. Generally, most gifts to a trust of more than £325,000 (tax year 2009/10) are taxed at 20 per cent IHT at the outset, but there are some exceptions to this. Gifts are typically under this amount and so avoid this IHT bill.

However, with so much to think about with trusts, taking independent legal advice is the only way to ensure you have covered all the bases, from trust choice to the tax treatment.

Further reading:

Where thre's a will...
Effective IHT planning