Interest in Possession Trust - Choice of Investments

North4

I am one of the Trustees for an Interest in Possession Trust. The Trust was created on my father's death, as per his will. The will states that a certain percentage of the Estate should be invested in Trust to provide growth and income, and for the income to be paid to his surviving spouse. The remaindermen are his grandchildren.

As Trustees we have to decide (possibly with the help of an IFA) where to invest the money and we need to treat the tenant and the remaindermen fairly.  It's particularly relevant now interest rates and bond yields are low and dividend income is under pressure. Obtaining levels of income that may have been available many years ago, and even 9 months ago, may not be possible, or if it is may have a significant impact on the future growth in value of the Trust.

Are there any specific rules or guidance about how to balance income v capital growth in a Trust of this type.

xylophone

Are there any specific rules or guidance 

No - the investments may be held by a Trust but in essence there is the same decision to be made as for any investor - is the aim to maximise income or growth or to attempt to balance the two.

https://techzone.adviserzone.com/anon/public/iht-est-plan/Tech-guide-IIP-trust-taxation may be of interest.

https://www.gov.uk/trusts-taxes/trusts-and-income-tax

You will need to set up an account in the name of the Trustees.

Example https://www.share.com/globalassets/assets/downloads/trust_share_account_application.pdf

You will also need a current account in the name of the Trustees. Metro Bank and Natwest have recently been mentioned in this regard.

If you need to hold a certain amount in cash, NS&I permit certain products to be held in Trust.

For a general read round, https://moneytothemasses.com/saving-for-your-future/investing/reader-q-where-should-i-invest-100000-to-generate-income  and 

https://moneytothemasses.com/saving-for-your-future/investing/how-to-invest-100000-for-the-best-return-and-growth

may be worth a look.

If you have no experience in choosing or managing investments, an IFA can advise.

https://adviserbook.co.uk/

You would tick "confirmed independent" and  other specialisms as you require when the menu comes up.

dunstonh

Obtaining levels of income that may have been available many years ago, and even 9 months ago, may not be possible, or if it is may have a significant impact on the future growth in value of the Trust.

Why?

high yield portfolios have been out of fashion for over a decade. Total return is the most popular method for income provision nowadays. And there is nothing going on that is impacting on that.

bowlhead99

dunstonh said:

Obtaining levels of income that may have been available many years ago, and even 9 months ago, may not be possible, or if it is may have a significant impact on the future growth in value of the Trust.

Why?

high yield portfolios have been out of fashion for over a decade. Total return is the most popular method for income provision nowadays. And there is nothing going on that is impacting on that.

But the OP's point is that the trust rules provide for the income to be paid to person A and the residual capital plus growth to be kept by person B.

You are right that if you or I were investing a sum of money for ourselves or our families it would be quite normal for us to invest with the aim of generally improving our overall wealth on a total return basis.  Subject to any tax specifics (not relevant within pensions and ISAs etc) we could be largely indifferent between getting 4% income 4% growth; 3% income 5% growth; 2% income 6% growth, etc etc.

If we wanted to get our hands on 3% of the pot each year to give ourselves some spending money, that might involve taking 3% natural income if that's coincidentally the same amount that has been generated by the portfolio. But if the natural income were only 2% within the total return we would top it up by selling some capital, while if the natural income was 5% and we only wanted 3% we would just reinvest some of it. As long as the total return is decent for the risk and volatility being taken on, the fine detail of exactly what natural income is generated as a proportion of the total return is something that doesn't need to overly concern us.

The OPs issue is that the split between income and capital *does* concern the beneficiaries, whose split of the trust returns are carved up on income and capital lines. The current economic conditions and prevailing interest rates mean that the natural income yield of a typical moderate risk portfolio will inevitably be lower than it was a year ago or a decade ago, because interest rates and bond yields are lower (and for certain equities, dividend cuts may have reduced the expected short-term yield more than they have reduced the prospective growth). In the income in possession trust, person 'A' is going to get the ongoing 'income' from the portfolio but persons 'B' will eventually inherit the residual value. So if the natural yield falls due to market conditions, person A's return will fall, while if interest rates and inflation were higher, person A would be naturally be taking more money out even if the long term real terms return were unchanged.

The trustees want to treat the beneficiaries 'fairly' while structuring a portfolio for a mix of income and growth. As interest rates have fallen, and the returns from fixed interest assets such as cash and bonds would form part of the return of a normal mixed asset portfolio, it does seem 'fair' for the trustees to simply say to the income recipient 'A' that they are not currently getting a lot of income because typical investment portfolios have stopped generating as much income. As OP suggests, maintaining whatever level of income was achieved some time ago is something that, "may not be possible, or if it is may have a significant impact on the future growth in value of the Trust".

In other words, the trustees could still get 4-5% income from a portfolio by tilting it towards specific types of assets (bonds, especially those with lower credit quality, and particular types of equities) and pay the resulting income out to the person who holds the interests in possession (A) but that could adversely impact what would be left over for the other beneficiaries (B).

If the trust portfolio is still 'fit for purpose' (and the purpose is the generation of "a mix of income and long term capital growth") and there is no specific income level mandated, there should be no need to overtly tilt the portfolio to favour the income objective if the natural income declines. As per Donald Trump's reaction to some question recently, simply shrug and say, "it is what it is".

But if the trust deed doesn't speak to any sort of longer term growth objective for the benefit of B and simply says that the assets are to be invested to provide an income for A, while the capital will be eventually passed to B after A's passing, then it isn't unreasonable to aim for a bit more income if the originally selected portfolio is no longer doing a satisfactory job of providing an income to A. The only consideration or compromise there would be is between A getting income now, and A still being able to get a decent income in real terms in the future, requiring some use of growth assets to maintain the real terms amount of assets that are available to generate income in the future.

So it's important to understand what the purpose of the trust really is, because being 'fair' to the beneficiaries in carrying out the trustees' fiduciary duties does not necessarily mean that beneficiaries A and B must receive the same amount of money - especially as the length of time that A will be alive is an unknown factor.

In considering how to invest the money the trustees shouldn't act other than in a way that a reasonable professional person would behave, so may need to take professional advice both on the objects of the trust (solicitor) and how to generate returns that fulfil the objective (IFA). Certainly for the latter there is more than one way to skin a cat and OPs question is whether there is a standard way of acceptable cat-skinning which would not be seen to unduly bias the outcome towards one beneficiary or another, in the event that the trust's language around having to invest for income and growth/capital is quite generic and allows the trustee to just focus on delivering a decent total return rather than having an income or capital target.

While I don't have an exact answer to that, perhaps I've helped to explain what the OP is concerned about. I don't think xylophone's well-meaning suggestion that the trust will need a bank account, or dunstonh's observation that people usually invest for total return rather than high yield, will have solved the problem either. But the trust deed itself, or perhaps a will that caused it to be established, should be examined to see what the trustees are supposed to be doing. The trustees might have in their heads that they are trying to make sure the pot for the grandkids grows, or deliver a good amount of income to the spouse, but those might not actually be the requirements. If 'a bit of both' is allowed then it is probably fine to just invest in a mixed asset portfolio with a sensible risk profile and let the income be what it will be.

North4

Thanks bowlhead for your comprehensive answer, which identifies very accurately the issues that I am faced with as a trustee. I will need to read it through a few times to understand all the aspects and relate it to our situation. I think I'm going to involve an IFA in it for a number of reasons, but I still want to be able to understand what flexibility, options and constraints there might be. One problem is that the will was originally written 20 years ago. At that time the investment landscape was very different and the financial situation of those involved has changed as well since.  

xylophone - Thanks for the links,they provided some useful leads.

dunstonh: Total return was something that I have in mind as a more effective way of managing the investments, but I can't see how that can be applied to a trust where income and capital growth go to separate beneficiaries. As bowlhead also pointed out. It seems to me that once the income and growth have been created there may be no discretion to divert those different streams. The only way of altering who gets what is by choice of investments within the Trust.

North4

bowlhead99 said:

But if the trust deed doesn't speak to any sort of longer term growth objective for the benefit of B and simply says that the assets are to be invested to provide an income for A, while the capital will be eventually passed to B after A's passing, then it isn't unreasonable to aim for a bit more income if the originally selected portfolio is no longer doing a satisfactory job of providing an income to A. The only consideration or compromise there would be is between A getting income now, and A still being able to get a decent income in real terms in the future, requiring some use of growth assets to maintain the real terms amount of assets that are available to generate income in the future.

That's pretty much what it says. Just to clarify, the Trust exists because it was created at the time of death earlier this year. At the moment there is nothing in the Trust until such time as money is payed into it from the Estate  It will therefore be a new set of investments from scratch and there is no previous income level to start from.

xylophone

I don't think xylophone's well-meaning suggestion that the trust will need a bank account, 

How extraordinarily patronising!

If you would read my post carefully, you would note that (on the assumption that the OP had no experience of Trust administration), I gave links to a note on aspects of taxation of an IPDI, an example of a platform and also reminded him that a Trust current account would be needed.

In terms of his question on income and growth, I linked to a couple of articles discussing this aspect.

Clearly the OP did read my post with some attention and has acknowledged the links.

bowlhead99

xylophone said:

I don't think xylophone's well-meaning suggestion that the trust will need a bank account, 

How extraordinarily patronising!

If you would read my post carefully,

I did read your post and the links etc would be useful for someone starting out, with your first sentence "is the aim to maximise income or growth or to attempt to balance the two" being a sensible starting point to the thread title of "Choice of investments".

The only question the OP had put to us was:

As Trustees we have to decide (possibly with the help of an IFA) where to invest the money and we need to treat the tenant and the remaindermen fairly.  It's particularly relevant now interest rates and bond yields are low and dividend income is under pressure... ...Are there any specific rules or guidance about how to balance income v capital growth in a Trust of this type?

The knowledge that Metro and NatWest offer current accounts for trusts, or that high yield portfolios are out of fashion, is all good stuff, and well-meaning, as people on this forum are a helpful bunch. My language wasn't intending to deride your efforts, which would give a good backstory to what trusts do and how they are taxed, and how people invest.

But when I read those answers I wondered whether the people writing the replies had actually seen the crux of the problem - which is why much of my reply was dedicated to laying out the OP's question so that future visitors to the thread could perhaps better 'get' what the question was and why he was asking it, in the hope of receiving better insight.

North4

xylophone said:

 It seems to me that once the income and growth have been created there may be no discretion to divert those different streams. 

I cannot see how this would be the case.  My relative is Trustee of a family trust - it was "settlor interested" which is different from an IPDI but nevertheless, the aim was to apply income to the settlor while preserving capital for those beneficiaries who would be left once the settlor had gone to meet the ancestors.

As it happens, because the settlor decided that she no longer needed the income, it was decided  (after consultation with solicitor etc), to liquidate the investments to enable the Trust to lend cash to the settlor (who used it to make PETS (which did in fact become ETS) with the debt to be set against the settlor's estate on death, when the Trust became fully discretionary.

The investments that had been in the Trust were largely shares (which over the years gave income and growth) but there were some bonds/gilts etc.However, the choice of the investments (and any change of investment) was at the discretion of the Trustees (although I seem to recollect that there was a stockbroking firm involved at one time as well). My relative was not wholly happy with that arrangement - he thought that there was a degree of "churning" involved  and eventually took charge of the investments with the  Settlor and a replacement Trustee. 

It seems to me that the Trustees of this IPDI should be discussing the income needs of the life tenant with her - it may be the case that she does not want or need income on a regular basis or would prefer to aim for growth  now with a view to taking income in the future, perhaps when a need for care emerged.

It is also possible that she would wish the future needs of her grandchildren ( the remainder men) to be paramount?

To be clear, by "once the income and growth have been created" I meant that a dividend had been received, or an investment had grown in value or an annual bonus had been received etc. - all from the existing investments. As I understand it the Trustees have discretion to change the investments to meet the objectives of the Trust. But I don't think that they have discretion to take some of the income and keep it for the remaindermen or use some of the growth to pay additional income to the tenant.

Your point relating to the income needs of the life tenant is one that I have been considering as well. The advice I've had to date is that the Trustees should not concern themselves with the position of the tenant - that is something for the tenant to decide how they use the income that the Trust provides them. It's not a view that I necessarily share but I'm not a legal expert and I do recognise that it is not a discretionary Trust. If a tenant has very little other income now then generating more income now for the tenant might be justified even though in the long term the value of the Trust might not grow and they will, in real terms, see a decline in the income from the Trust in the future. At the other extreme, the tenant may have more than enough income from other sources now but would benefit from growth in the value of the Trust, and growth in the income it produces to be able to fund higher (e.g. care) costs in the future. However, such considerations may be constrained by legal interpretations of the purpose of the Trust. Any flexibility is mainly in the choice of investments and it may end up that we interpret the Trust objectives as a 'bit of both' in relation to income and growth.

Another valid point about the wishes of the tenant and would they wish to the future needs of the grandchildren to be paramount. Again the legal position might be that the tenant has no real say in how the Trust is run and must accept the income that it gives, provided that it is done fairly.

xylophone

The  will is clear that a certain percentage of the estate funds is to pass into an  interest in possession trust  and be invested/deposited to provide growth and income and that the income is to be paid to the Life Tenant.

The Trustees have the right to choose the investments but as the Life Tenant has the right to income, it seems to me correct to consult her on the subject.

You do not have to be bound by her views but it would help in clarifying the strategy  that might be adopted?

Dead_keen

I don't know the answer to your questions but generally the trustees have an overall duty to strike a fair balance between capital and income beneficiaries and this must, necessarily, inform the trustees’ investment decisions. 

What does a fair balance mean? I have no idea as it's not my area.  But for background you might want to look at the Law Commission Report (Report No 315, 2009), Capital and Income in Trusts: Classification and Apportionment.  Section 5.20+ is interesting: https://www.bailii.org/ew/other/EWLC/2004/175(5).html  

This mentions the Nestle case.  Reading court cases can be difficult but there is a bit of background on wiki: https://en.wikipedia.org/wiki/Nestle_v_National_Westminster_Bank_plc and it contains links to the actual cases (easiest place to start in reading the case is probably to ctrl-F "fairly").

You then need to add in what the law says (e.g. Trustee Act 2000 - https://www.legislation.gov.uk/ukpga/2000/29/contents ) and what the terms of the trust are (e.g. does it refer to STEP Standard provisions 2nd edition which might be incorporated by reference?). 

Certain obligations underpin a trustee’s statutory power of investment (section 4) so regular reviews of investments are necessary and consideration should be given as to whether investments should be diversified, ect.  When investing, the trustees must either comply with the statutory duty of skill and care (contained in section 1) or the common law duty of care to act as a prudent man of business would in making the investments. 

The terms of the trust may also disapply the general duty to hold a balance between the conflicting interests of beneficiaries.  Depending on how the will is written this might be quite straightforward (e.g. The trustees are under no duty to hold a balance between conflicting interests of persons interested in the trust property) or quite cryptic (e.g. it may incorporate the STEP Standard Provisions 2nd Edition by reference).  You can find the STEP Standard Provisions here: https://www.step.org/public-policy/step-standard-provisions - have a look at clause 21 if it does.

If there is a disapplication of the trustees' duty to strike a balance between beneficiaries, the implication is that the trustees must still act rationally and impartially. As such, they should have to have a reason for skewing their investment policy in favour of capital rather than income (or the other way around). Some reasons for not maintaining a balance might be:

• a concern that income generated will be used up to pay for care that would otherwise be paid for by the state, 
• a desire to provide a life tenant with accommodation (thus depriving the trust of rental income), and
  
• the wishes of your father for capital growth
  

Once you know all this, the trustees can decide what version of fair they want to achieve.  Then they (perhaps with the help of an IFA) can decide what the investments will be and how / when they will review them.  

In terms of talking to the beneficiaries, I have no practical experience and think it would be important to understand (i) what the terms of the trust say about that (probably nothing), (ii) what your father's wishes were (e.g. based on conversations you had before he died), and (iii) what the beneficiaries are like.  In this were my family, I'd be having open conversations about the role of the trustees, the issue of balance and the choice of underlying investments.  This may bring out particular issues (e.g. the surviving spouse may not want to be the life tenant and the assets should go the grandchildren when they are old enough) or whatever.  But knowing my family, I'd be relaxed about family harmony.  On the other hand, if I thought it was going to cause a lot of family tension then I'd want to frame the conversations around "the trust rules limit what we can do, this is what you should expect in terms of income".