Discretionary Trusts and tax

electricdreams

Hello there

Firstly, this is my first post so I apologise if it's in the wrong place

A bit of background: My dad died 13 years ago, and my mum (who never remarried and is still single) is now terminally ill. I have a brother and a sister, who are both married (my sister has children but neither my brother or I do yet). I am single.

Mum's estate is likely to go a bit over the threshold for inheritance tax (taking into account the transfer of my dad's nil rate band to her) When mum was diagnosed she set up a will with 3 discretionary trusts wrapped up in it, and a letter of wishes stating her estate is to be split equally between me, my brother and my sister, with a separate trust for each of us.

What are the tax implications for this? And what are on-going administration cost implications likely to be? I understand that it protects our inheritance from divorce etc, but are there any other benefits? I'm concerned about the tax implications for us, I presume we're going to have to fill in tax returns every year etc. I'm 32, and not the tax/accountancy savvy of people!

I'm one of the executors of her will, along with the solicitor (the solicitor is also a trustee, I think, on each of the trusts). So I'm worrying in advance about things being very complicated and I'm also worrying about making a hash of things. I've got enough to worry about at the mo with mum being so poorly and care-dependant, and this is just adding to my woes. I'm stressing that we've all (mum included) agreed to the wrong thing. Any advice would be gratefully received

dzug1

I suspect you are right to worry, but at this stage there's not a lot you can do unless your Mum is well enough to rethink her intentions - and wants to.

http://www.is4profit.com/is4money/tax/discretionary-trust-wills-inheritance-tax.html is a good guide to discretionary trusts.

Yes there will be tax returns every year - but I imagine the solicitor would handle them. Such trusts are taxed at a high rate - but the beneficiaries may be able to reclaim some of it.

Main running costs will be the solicitors fees - at a wild guess I'd say several thousand a year.

It's not clear what your mum was trying to achieve - I can't see any IHT benefit but loads of tax disadvantages. Sounds like she either doesn't trust you or didn't understand what she was doing. Or her solicitor saw a gravy train.

A deed of variation (to disregard the will and share the estate in a different, agreed, way) might be possible post death. Who would be disadvantaged if this were to be done?

Others more expert than I may have some ideas/corrections to the above.

Baggysdad

Its difficult to answer your question from the brief information.

But I am guessing that your mother has either
1) Left her estate in her will into 3 discretionary trusts created by the Will. The estate will pay inheritance tax on the amount above the IHT threshold available to your mum, including your dads portion. The trusts will then pay tax every 10 years on the amount of the accumulated value of all 3 trusts that is above the IHT threshold at that time. The tax rate is 6%.

or
2) Left her estate in her will into 3 discretionary trusts created by her during her lifetime. The estate will pay inheritance tax on the amount above the IHT threshold available to your mum, including your dads portion. The trusts will then EACH pay tax every 10 years on the amount of that EACH trust is above the IHT threshold at that time. The tax rate is 6%. I hope you can see that there is much less chance of paying tax this way.

How much does it cost to run these trusts? Well it depends on how they are run - and that is a decision for the trustees. Income tax on the trusts is currnetly charged at 50% of the income. But this can easily be side stepped by investing in funds which return capital growth rather then create income. Income tax returns need to be completed each year, but if the funds have been invested so no income is generated, HMRC can waive this requirement - which means no work and no fees from the trustees.

These trusts work very well as long as the trustees know what they are doing.

The other thing to think about is that these trusts are your mums wishes. There is more to life (and death) than saving tax and saving fees and if these trusts have given your mum the assurances that she finds comforting, then so be it.

electricdreams

thanks for the replies.

Baggysdad - the trusts have been set up already. The thing I can't get my head round is that, because none of us kids have much money, any inheritance will no doubt be used for housing and then just general living, as opposed to being invested in funds etc. So I have no idea what the implications are for this.

I know it seems I'm putting the cart before the horse here, but I'm one of those people who get wound up about doing things properly, and I want to be sure I'm doing right by mum (and dad!), especially as I'm executor. I think I've got a lot of reading up to do!

Thanks again for the replies

SeniorSam

electricdreams wrote: »

Hello there

Firstly, this is my first post so I apologise if it's in the wrong place

A bit of background: My dad died 13 years ago, and my mum (who never remarried and is still single) is now terminally ill. I have a brother and a sister, who are both married (my sister has children but neither my brother or I do yet). I am single.

Mum's estate is likely to go a bit over the threshold for inheritance tax (taking into account the transfer of my dad's nil rate band to her) When mum was diagnosed she set up a will with 3 discretionary trusts wrapped up in it, and a letter of wishes stating her estate is to be split equally between me, my brother and my sister, with a separate trust for each of us.

What are the tax implications for this? And what are on-going administration cost implications likely to be? I understand that it protects our inheritance from divorce etc, but are there any other benefits? I'm concerned about the tax implications for us, I presume we're going to have to fill in tax returns every year etc. I'm 32, and not the tax/accountancy savvy of people!

I'm one of the executors of her will, along with the solicitor (the solicitor is also a trustee, I think, on each of the trusts). So I'm worrying in advance about things being very complicated and I'm also worrying about making a hash of things. I've got enough to worry about at the mo with mum being so poorly and care-dependant, and this is just adding to my woes. I'm stressing that we've all (mum included) agreed to the wrong thing. Any advice would be gratefully received

Just to clarify a little further, the allowance before inheritance tax in your mothers case is her allowance and your father's, so £650,000 in this tax year before any inheritance tax will be payable at 40% above that amount.

The taxation of the discretionary trusts will depend upon what they each hold. If the holdings are investment bonds, then there will be no need for tax returns as there would be no 'income' for the Trusts to declare, as bonds have 'growth' (or loss as the case may be ). When were they set up?

Knowing the actual value of the estate would help as there are many types of trust that can be set up to help mitigate inheritance tax, more importantly, the contents of each trust now, or if the are to hold assets following your mother's death?

It is important that the family are fully aware of all the implications of trusts and knowing who set them up for your mother would also be of benefit in offering further guidance for consideration.

SeniorSam

electricdreams

Wow, it's been a long time since I have been on here. Thank you to those who replied. Apologies for my lack of response.

My mum died a week after I posted this, so as you can imagine, things have been a little disorganised and hectic. We have been through probate and the solicitor is now asking us to make the decision whether we wish to carry on with the trusts or wind them up.

Two of the trusts were set up on different dates during mums lifetime and the third was in her will, keeping each below the IHT threshold and therefore avoiding the recurring 10-yr anniversary charge.
She tells me that if would be possible to borrow the full balance of the trust (about £200,000 for each) on an interest free loan, which could be carried over indefinitely with a yearly review, therefore avoiding any extra income tax on it and also avoiding the need for tax returns. We are our own trustees. Is this correct? What I don't understand is what happens when we die, if we have spent some or all of the money, what happens to the debt to the trust? We all intend to buy a house with all or some of the money.

Also, a portion of the estate is made up of some gold sovereigns. Most of these are due to be sold, but each of us want to keep a few thousand pounds' worth as an investment. When these coins are sold, will any taxes arise because of the trusts? As I understand it, normally sovereigns are exempt from CGT. And will there be any tax implications because of the rise in the gold ,market since probate was granted a few months ago?

I am sorry for the lengthy post, but if anyone could answer any of these questions, I would be incredibly grateful. The whole thing is causing me a lot of stress - I want to do the right thing, and am terrified of making the wrong decision

I am a little concerned that, as laypeople, we could be agreeing to something we don't really understand.

SeniorSam

Hello again,

so sorry to hear that you Mum has passed away. Not easy for anyone.

With regard to her Will, the earlier value of all her assets are not important, as all assets will have been valued at the date of her death. Similarly, the assets of your father were valued at the time of his death and since they were in Trusts to the family, any gain of assets from the date of his death to the date of encashment may be attributable to CGT if it exceeded the limits. The CGT allowanace is only 50% of normal for Trusts, but I would expect your solicitor to guide you on this.

The Trusts established by your father could either be wound up, or continued up to 80 years from inception if required. This is one of the ways that very wealth families retain their wealth and yet have access via Trustees.

If Trusts were retained, the Trustee could make loans to anyone, but all must agree. Therefore, the eventual beneficiaries may wish to request the Trustees make them loans from time to time. In this way, the Trust values could be retained, as the value would be owed back to the Trust by the lender. This can be a good way to help reduce the beneficiaries own IHT liabilities in the future, when they die. Also as Discretionary Trusts, the assets held are not deemed to be owned by the beneficiaries, but by the Trusts and values cannot be considered if care costs were needed in the future.

The beneficiaries could add their own beneficiaries at any time, although if the present Trustees of the Trusts are in agreement, they could agree to ensure that the present beneficiaries value can pass on to whoever they wish to nominate or suggest.

Don't worry about tax returns unless the Trusts generate an income. As previously mentioned, if assets are NON INCOME PRODUCING, then there is no tax return required.

As the solicitor has already said, the value of the Trusts can be distributed by loans to the beneficiaries, They can then do what they like, but that amount is safeguarded for their own beneficiaries.

Even if the Trusts remain, there will be no 10 year tax on the Trust unless each Trust value exceeds the nil rate band allowance, which is doubtful.

Do consider the position regarding Trustees. It need not be so complicated to deal with the Trusts yourselves and it would save a great deal of solicitor fees. However, if you are unsure and are prepared to pay solicitors costs, then it's your choice, but get the costs clarified before instructing the solicitor. Many solicitors charge what they can, but do negotiate charges first.

I hope I have not confused you,. Please ask for clarification if you wish

Sam

System

I'm not an expert, but have experience of operating a trust now 4 years since my father's death set it up.

I do have to do an annual tax return, but it is quite easy to follow the guidance notes, and the tax helpline is good. They are sympathetic to new amateur trustees doing it for the first time, and will talk you through which boxes to fill in on the form.
After the first year its just a matter of doing the same thing next year.

If the trust has income it will suffer a 50% rate, but the trick is to distribute just enough to beneficiaries who have nil tax rates, like children, students, non-working spouses, etc. That way they get back all the tax the trust has suffered.

It would get more complicated once you start switching investments and having to think about capital gains tax, but I haven't reached that stage yet.

My advice would be to ditch the solicitor trustee and do it yourselves, but perhaps later go to a tax consultant for specific help if you find you need it.

electricdreams

Thank you for your replies. Senior Sam, when my father died there wer no trusts in place. That didn't happen till my mum set them up in 2009. I am still worrying about the gold sovereigns - the value of these has gone up considerably since probate was granted on my mum's estate, and no tax would have been payable if they were outside the trust.

Also, what happens if we borrow the value of the trust in interest free loans, and then spend some of it - eg on a car or a holiday That would create a debt on the estate and yet the the money has been spent.

Clifford_Pope, my siblings and I are both the beneficiaries and the trustees of our own individual trust. We are all basic rate tax payers. Only my sister has children and I am single so haven't got any non-tax payers to start giving money too

Thanks again for your help. I'm starting to feel I understand the whole thing a little better now

SeniorSam

Hi again,

sorry I got that wrong, I have just re-read earlier messages. However, with his assets passing to your mother you know you have both nil rate band allowances before any IHT.

The sovereigns value increase will need to be accounted for if inheritance tax is an issue, because probate values are only deemed to be an estimate of value at the time of death. Quite often property values change between date of death and sale of property. If lower sale achieved, then any IHT can be reduced accordingly. Similarly any increase may unfortunately increase the tax liability.

Regarding the loans that Trustees can make to beneficiaries, or whoever they see fit, if the money loaned is all spent and the recipient's estate value at date of death is nil, then nothing happens. If that estate does have a value at date of death, then that value is reduced by the loan, which is repaid to the Trust and passed on to others who may be nominated in the Trust, or as the remaining Trustees see fit.

It's just a case of thinking matters through and deciding what you would wish to happen to that Trust fund when you are gone .................. perhaps to be passed on to your sisters children? You only need make the Trustees aware of your wishes and if you trust them, it should be be OK.

Hopefully you will have plenty of time to learn more as time passes and sites such as this will always find people with knowledge to help you. This is why for simple Trusts, it is not really a problem for the family to be Trustees rather than professionals such as Solicitors and Accountants, as their fees can be huge.

All the best

Sam