Can You Avoid Taxes with a Trust? HEATHER ROGERS debunks some common myths

Heather Rogers is the founder and owner of Aston Accountancy and the tax expert at This is Money.

One of the most common misconceptions I encounter in my professional life concerns trusts. There are many misunderstandings about its operation and tax implications.

There seems to be a widespread belief that if you put assets into a trust, you don’t have to pay any taxes at all. Unfortunately, this is rarely the case.

Here I’ll go through the main types of trusts, how they work, what they’re used for and the ways they can be useful, to debunk some myths.

What is a trust?

In a trust, assets are managed by a person or persons called trustees for the benefit of another, the beneficiary or beneficiaries.

The person who puts the assets into the trust is called the settlor. When a trust is set up, there is usually a trust deed or will that determines how the assets are managed.

The trustees are responsible for the assets in the trust. They manage the trust, prepare tax returns, pay tax obligations, and decide how best to invest or use the trust’s assets.

Assets can include land and real estate, shares and cash.

Why put assets in custody?

The typical reasons for setting up a trust are as follows:

– Protection of family assets;

– A person is too young to manage his affairs;

– Someone is incapacitated for work and cannot arrange his affairs;

– The settlor wants to pass on assets during life or after death in a way that he can control himself.

Assets can be transferred into a trust while a person is still alive in a lifetime trust, or after death using a will.

Almost all trusts must be registered with the trust registration service.

Let’s take a look at some of the most commonly used trusts.

Bare relationships of trust

This is the simplest form of trust. The trustees manage the assets until the beneficiary reaches legal maturity.

The beneficiary is entitled to all income and capital once he reaches the age of 18 (16 in Scotland).

A transfer of assets to a bare trust does not trigger estate taxes for the settlor, and the assets in the trust will form part of the beneficiary’s estate, not the settlor’s.

The settlor’s estate therefore does not have to pay inheritance tax.

Income and profits are taxable to the beneficiary, regardless of their age, unless:

– A parent of the beneficiary is the founder and the income is more than £100 per year, in which case it is taxed on the parent;

– The settlor or his/her spouse retains an interest, for example by receiving income from the property held in the bare trust.

Interest in property trust

These are usually created upon death. The beneficiary immediately receives any income from the trust directly from the trustees, or the use of the assets held in trust, but has no control over the assets themselves.

The income they receive may be income from a rental property or dividends from shares in a company, but the beneficiary has no rights to the property or shares passing to a third party, for example the settlor’s children.

If the income is mandated to the beneficiary (meaning it goes directly to him or her), the income is taxed to the beneficiary.

If not, the trustees will pay tax: 8.75 percent on dividend income and 20 percent on everything else.

Sometimes there is no income other than the right to use the property, for example the family home for a surviving spouse during his lifetime, but the home passes to the children upon the death of the spouse.

This is often used to protect children from disinheritance should the surviving spouse remarry.

The assets would still be in the settlor’s estate for estate tax purposes.

Discretionary trusts

A discretionary trust is just that. The trustees have full control over the assets and the income generated from them and they decide how and when to give the income and assets to the beneficiaries.

Depending on the trust deed, trustees can decide:

– What is paid out to the beneficiaries – this can be income or capital;

– To which beneficiary(ies) payments should be made;

– How often payments are made to beneficiaries;

– Any conditions to be imposed on the beneficiaries.

One use of this trust could be for a grandchild who may need more financial assistance than other beneficiaries at some point in his life, and also for beneficiaries who are not able or perhaps responsible enough to manage money on their own.

Often the grandparents set up the trust, with the parents as trustees.

Sometimes they are used to protect family assets.

The trustees pay tax on the income, with the first £1,000 taxed at the same rate as interest on property trusts and the remainder of the income taxed at 39.35 percent on dividend income and 45 percent on all other income.

Things are more complicated for inheritance tax. Because the beneficiaries do not have any rights to the trust fund itself due to the nature of the trust, it is generally not part of their estate in the event of divorce, bankruptcy or death.

Because of these benefits, depending on the amount held in escrow, there is often a tax charge on the invested assets, 10-year fees and exit charges when the assets come out.

However, a settlor can transfer an amount into the £325,000 (£650,000 for a couple) zero rate range every seven years without an entry charge, provided they have not previously used any of their zero rate range on similar transfers in the previous seven years. .

If the settlor puts more than this into the trust, the settlor pays a 20 percent tax on the excess. If the settler dies within seven years, more taxes may have to be paid.

If the discretionary trust is created in a will, all assets are subject to inheritance tax in the normal manner. There are no savings on inheritance taxes. However, no further charges will apply to the assets placed into trust.