UK: WHEN TO PLACE TRUST IN A FUND. - Trust funds can be a highly effective and tax-efficient means of passing on family wealth, while at the same time keeping control. Nick Hasell looks at the benefits of three common types.

Last Updated: 31 Aug 2010

Trust funds can be a highly effective and tax-efficient means of passing on family wealth, while at the same time keeping control. Nick Hasell looks at the benefits of three common types.

Whether it's the popular image of their beneficaries as indolent young aristocrats, the legal wrangles they occasionally spark or the poor returns they sometimes provide, trust funds have often had a bad press. Indeed, when they draw attention it is usually because of some bitter family feud played out in the courts. Witness the bid by Lord Palumbo's two eldest children to have their father and stepmother removed as trustees of a £70 million family trust fund; or, more recently, the action brought by the daughters of Lady Dufferin, one of the Guinness family, to prevent her from leaving £15 million in trust to her grandchildren, rather than themselves.

Despite such spats, the trust fund has no shortage of advocates. 'Trust funds are a very effective way to pass on family wealth, and, at the same time, reduce your inheritance tax bill,' says Brian McRitchie, personal tax partner at Coopers & Lybrand. It is for the first of these two reasons, however - to control and protect assets - that most trusts are created. Usually they are used as a vehicle to hold assets in cases where the beneficiaries are not considered capable of looking after the assets themselves - due to either disability or, in the case of children, immaturity. They can also be used to provide security for a spouse or protect against legal claims. Either way, instead of an immediate and outright transfer of wealth to the beneficiary, assets are passed into the legal ownership of trustees who administer the fund and distribute the assets according to the deeds of the trust.

Trust funds commonly come in three types: interest in possession (or life interest) trusts, discretionary trusts, and accumulation and maintenance trusts. In the case of an interest in possession trust, the beneficiaries receive the income from the fund throughout their life as a right; the trustees must pay over the income and have no power to withold it. Reasons for their use vary: the settlor may be concerned over profligacy and require a certain degree of restraint; he or she may wish to provide income for the duration of one person's life, but ensure that the capital passes to someone else; or he may need to make a gift for tax planning reasons, but wish to retain flexibility over who will ultimately benefit.

As its name suggests, a discretionary trust gives the trustees wide powers over who receives income or capital, in what amounts and at what times. Unlike an interest in possession trust, the beneficiary has no automatic right to the income; indeed, if the trustees so decide, a beneficiary may receive nothing at all. Though the most flexible form of trust, it suffers from certain tax disadvantages. A transfer to a discretionary trust is liable to inheritance tax, which will be imposed at the lifetime rate of charge, currently one half of death rates. IHT charges also arise throughout the life of the trust.

There are other types of trust which receive favourable tax treatment, of which the third variety - the accumulation and maintenance trust - is one. These are typically used by a parent or grandparent to provide funds for the benefit of children who, at the time of making the trust, must be under 25. Here the beneficiary is either entitled to the capital at the age of 25 - at which point the trust ends - or, more usually, he or she receives the income from the fund. The principal advantages are that the trust doesn't close until the youngest beneficiary reaches 25, and hence is quite flexible, and that in tax terms it is classified as a potentially exempt transfer, so that no inheritance tax is chargeable during the trust's lifetime or when it ends.

But when is the right time to create a trust? McRitchie cautions against giving away too much too soon. 'What you are doing in making a trust is giving away your wealth to somebody else,' he explains. 'If something unforeseen happens, you might be left in later life with very little wealth. By then it is too late - the money is no longer yours.'.

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