Held for the benefit of a specified beneficiary
They’re also known as ‘Absolute’ or ‘Fixed Interest Trusts’, and there can be subtle differences. The settlor – the person creating the Trust – makes a gift into the Trust which is held for the benefit of a specified beneficiary. If the Trust is for more than one beneficiary, each person’s share of the trust fund must be specified. For lump sum investments, after allowing for any available annual exemptions, the balance of the gift is a potentially exempt transfer for Inheritance Tax purposes. As long as the settlor survives for seven years from the date of the gift, it falls outside their estate.
The Trust fund falls into the beneficiary’s Inheritance Tax estate from the date of the initial gift. With loan Trusts, there isn’t any initial gift – the Trust is created with a loan instead. And with discounted gift plans, as long as the settlor is fully underwritten at the outset, the value of the initial gift is reduced by the value of the settlor’s retained rights.
When family protection policies are set up in Bare Trusts, regular premiums are usually exempt transfers for Inheritance Tax purposes. The normal expenditure out of income exemption often applies, as long as the cost of the premiums can be covered out of the settlor’s excess income in the same tax year, without affecting their normal standard of living.
Where this isn’t possible, the annual exemption often covers some or all of the premiums. Any premiums that are non-exempt transfers into the trust are potentially exempt transfers. Special valuation rules apply when existing life policies are assigned into family trusts. The transfer of value for Inheritance Tax purposes is treated as the greater of the open market value and the value of the premiums paid up to the date the policy is transferred into trust.
There’s an adjustment to the premiums paid calculation for unit linked policies if the unit value has fallen since the premium was paid. The open market value is always used for term assurance policies that pay out only on death, even if the value of the premiums paid is greater.
With a Bare Trust, there are no ongoing Inheritance Tax reporting requirements and no further Inheritance Tax implications. With protection policies, this applies whether or not the policy can acquire a surrender value. Where the trust holds a lump sum investment, the tax on any income and gains usually falls on the beneficiaries. The most common exception is where a parent has made a gift into Trust for their minor child or stepchild, where parental settlement rules apply to the Income Tax treatment.
Therefore, the trust administration is relatively straightforward even for lump sum investments. Where relevant, the trustees simply need to choose appropriate investments and review these regularly.
With a Bare Trust, the trustees look after the trust property for the known beneficiaries, who become absolutely entitled to it at age 18 (age 16 in Scotland). Once a gift is made or a Protection Trust set up, the beneficiaries can’t be changed, and money can’t be withheld from them beyond the age of entitlement. This aspect may make them inappropriate to many clients who’d prefer to retain a greater degree of control.
With a Loan Trust, this means repaying any outstanding loan. With a discounted Gift Trust, it means securing the settlor’s right to receive their fixed payments for the rest of their life. With protection policies in Bare Trusts, any policy proceeds that haven’t been carved out for the life assured’s benefit under a Split Trust must be paid to the Trust beneficiary if they’re an adult. Where the beneficiary is a minor, the trustees must use the Trust fund for their benefit.
Difficulties can arise if it’s discovered that a Trust beneficiary has predeceased the life assured. In this case, the proceeds belong to the legatees of the deceased beneficiary’s estate, which can leave the trustees with the task of tracing them. The fact that beneficiaries are absolutely entitled to the funds also means the trust offers no protection of the funds from third-parties, for example, in the event of a beneficiary’s divorce or bankruptcy.