Interest in Possession Trust - Choice of Investments

Doubledhelix

This thread is very useful. I'm a trustee and beneficiary of an IPDI, as are my brother and step-mother (no other trustees). My stepmother is the life tenant and my brother and I remaindermen. There are obvious conflicts of interest and no stipulation in the will/trust deeds as to the level of income to be provided.

We need to provide our trust fund investment manager with an investment policy statement that balances income and capital growth considerations - i.e. a reasonable income is generated for our stepmother and reasonable capital growth is also built into the portfolio structure. The fund manager requires more from us than a simple instruction to balance income and capital growth considerations.

I cannot find any guidance anywhere, or even examples, that would help inform our policy so it is workable and fair. IHT is a further complication for the poor fund manager, but if we could provide a clear policy on income/capital growth that would be a good start. Setting a specific amount of income per annum runs the risk (as has happened) that the capital is drawn on to meet income requirement. Alternatively could we agree a percentage return/yield per annum? The advantage of this would be the balance is maintained however the portfolio fares, the disadvantage that my stepmother would not have certainty as to her income each year. 

Despite all the useful links and explanations above I have the same question as North4 above: Are there any specific rules or guidance about how to balance income v capital growth in a Trust of this type?

poseidon1

North4 said:

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.

North, your own understanding in conjunction with Bowlhead's insightful comment on the rules related to life interest trust investing is correct. You will not be surprised to learn that there is a body of English case law in this area but now codified by the Trustee Investment Act 2000 which removed a number of archaic restrictions which affected the profitable management of Trustee funds.

You will need expert guidance in this area and it will not be just from a 'bog standard' IFA.

You will need to have annual accounts prepared in a specific format relevant to life interest trusts, as well as annual tax returns. So unless you feel  these are functions you could learn to handle yourself a good STEP ( Society of Trusts and Estate Practitioners) qualified accountant will be very helpful.

 Indeed if the firm actually administers family trusts on behalf of their clients you could find their experience and insight,  a fast track way in determining the best course of action for your entity

As for investment management, not all IFA's will have the relevant competencies in this  area and  depending on the amount of capital in the trust,  you should consider wealth managers such as Killick and Co, who have particular specialism in advising and assisting trustees.  

Finally, it used to be considered that a 4% income yield was a reasonable level to provide a fair income to the life tenant, and reasonable prospects for capital growth for the remaindermen. However, it would not surprise me if the decade of very low interest rates we have experienced may have changed the thinking in this area. Again specialist family trust advisors should be able to advise in this regard.

Best of luck, the pool of competent/knowledgeable advisers in this area is shrinking.

poseidon1

Doubledhelix said:

This thread is very useful. I'm a trustee and beneficiary of an IPDI, as are my brother and step-mother (no other trustees). My stepmother is the life tenant and my brother and I remaindermen. There are obvious conflicts of interest and no stipulation in the will/trust deeds as to the level of income to be provided.

We need to provide our trust fund investment manager with an investment policy statement that balances income and capital growth considerations - i.e. a reasonable income is generated for our stepmother and reasonable capital growth is also built into the portfolio structure. The fund manager requires more from us than a simple instruction to balance income and capital growth considerations.

I cannot find any guidance anywhere, or even examples, that would help inform our policy so it is workable and fair. IHT is a further complication for the poor fund manager, but if we could provide a clear policy on income/capital growth that would be a good start. Setting a specific amount of income per annum runs the risk (as has happened) that the capital is drawn on to meet income requirement. Alternatively could we agree a percentage return/yield per annum? The advantage of this would be the balance is maintained however the portfolio fares, the disadvantage that my stepmother would not have certainty as to her income each year. 

Despite all the useful links and explanations above I have the same question as North4 above: Are there any specific rules or guidance about how to balance income v capital growth in a Trust of this type?

Hi there, I assume you have delegated to your the trust investment manager full discretionary powers and this is the reason they require a detailed Investment Policy Statement  as set out in the Trustee Investment Act 2000 ( such a statement is not required if you have not delegated discretion).

If so please google 'Standard Life Investment Policy Statement'. The insurance company have produced a detailed template in pdf form, which assuming you can complete as necessary should provide the investment managers with the requisite compliance 'roadmap' to do the job. My apologies for not supplying a link to the form, was not able to do so.

As to income yield, you see from my post to North4, that 4% used to be considered appropriate for life interest trusts.

However it is important to note that you are not an annuity provider and so variation in the income payable to the life tenant is par for the course with these type of Trusts.

One needs to be careful with regard to capital distributions to the Life Tenant, if not authorised by the trust instrument. The fact that you and brother are the immediate remaindermen, mean you can 'forgive ' yourselves for impacting on your eventual capital entitlements. No doubt, you are maintaining formal trust accounts documenting when trust capital has been diverted to the life tenant?

Doubledhelix

Thank you very much Poseidon1, this is very useful, particularly the Standard Life form (unfort I'm not yet allowed to post links - I found it easily using your search term). Also clarification re variation in income and the trust's/trustees' responsibilities.

I did see your post re 4% yield - I've seen passing references to anything between 2-4% elsewhere, and 5% seems to be considered above reasonable expectation and likely to impact capital, but most are historical/pre-2019, and all pre-2022. Can you suggest where I might find more current, reputable (?) discussion of reasonable yield expectations?

As to your question, yes we do have records of trust capital diversions.

Thank you again for your extremely helpful (and quick!) response.

Malthusian

Although interest rates have gone up, the yield from a typical balanced investment portfolio (which will include equities and bonds, with only a small element of cash) hasn't gone up by much compared to the zero-interest-rate era. 2-4% still sounds about right; 4%pa would suggest some tilting towards equity income and/or high yield bonds. Vanguard LifeStrategy 60% currently yields 1.95%pa and L&G Multi-Index 6 currently yields 2.1%, to randomly name a couple of one-stop-shop mixed-asset portfolios with no particular income/growth objective. 

The terms of the Will and the intent of the father should be considered. If you invested the capital in a standard balanced portfolio and your stepmother received 2% of the capital per year (half the base rate), what do you think the testator/ix (your parent?) would think about it?

All the beneficiaries are trustees, so if you decide to prioritise income, and capital growth suffers as a result, you can't exactly sue yourselves after your stepmother dies.

I am not saying the trustees should prioritise income, even though it may sound like it. My point is that you have wide discretion - both legally and via the practical issue that all the trustees are beneficiaries - and the solution that results in the least conflict between the trustees / beneficiaries may well be the best one.

The fund manager requires more from us than a simple instruction to balance income and capital growth considerations.

What exactly are they asking for? "I want to take a balanced approach between income and growth" (which is option 1 in Standard Life's template) is a very normal instruction, almost certainly the most common kind of instruction, and the discretionary fund manager should have a model portfolio to cover it. 

Is there a particular reason to use this investment manager? If they are unable to follow simple instructions, the trust might be better off taking independent financial advice.

You will find little in the way of specific rules to follow. Nestle v NatWest (linked above) makes clear that the trustees have wide discretion if the terms of the trust don't say otherwise. In that case the trustees (NatWest) got a verbal kicking from the appeal court judge for how they'd managed the trust, but were not held to have breached their trust.

Doubledhelix

Thank you Malthusian, also extremely helpful. I'll have a look at the mixed asset portfolios you mention and some others for reference as this may help provide evidence-based benchmarks for discussion.

In terms of our father's wishes, his will simply stipulates the income is to be paid to our stepmother during her lifetime and the capital and income to be held on trust for my brother and me until the end of the discretionary period (sorry if I'm mashing legal language). To my untrained but now quite familiar eye there is no further guidance. He was very pragmatic and fair, and he didn't include any clauses in his *very* long will suggesting the trust portfolio should be tilted one way or the other, or providing for this in changed circumstances, of which to my knowledge there are none significant. As a trustee (albeit also a beneficiary) I am seeking a pragmatic and fair approach that balances the interests of life tenant and remaindermen, as I believe the settlor would have done/wished. 

For anyone considering setting up such a trust (IPDI, IIP) I would say that providing greater clarity on these matters, providing a letter of wishes and/or having conversations with trustees when the trust terms are being established would be extremely helpful!

poseidon1

Doubledhelix said:

Thank you Malthusian, also extremely helpful. I'll have a look at the mixed asset portfolios you mention and some others for reference as this may help provide evidence-based benchmarks for discussion.

In terms of our father's wishes, his will simply stipulates the income is to be paid to our stepmother during her lifetime and the capital and income to be held on trust for my brother and me until the end of the discretionary period (sorry if I'm mashing legal language). To my untrained but now quite familiar eye there is no further guidance. He was very pragmatic and fair, and he didn't include any clauses in his *very* long will suggesting the trust portfolio should be tilted one way or the other, or providing for this in changed circumstances, of which to my knowledge there are none significant. As a trustee (albeit also a beneficiary) I am seeking a pragmatic and fair approach that balances the interests of life tenant and remaindermen, as I believe the settlor would have done/wished. 

For anyone considering setting up such a trust (IPDI, IIP) I would say that providing greater clarity on these matters, providing a letter of wishes and/or having conversations with trustees when the trust terms are being established would be extremely helpful!

See below a useful commentary from Farrer & Co ( the late Queen Elizabeth's solicitors ) on the varied investment matters trustees should keep in mind in discharging their duties.

https://www.farrer.co.uk/news-and-insights/trustees-duties-and-powers-when-making-investment-decisions/

In your circumstances, what is an appropriate investment portfolio in terms of balancing the interests of life tenant and remaindermen will,  for example,  depend on the current age and state of health of the life tenant, and what happens to the trust fund on her death. You have intimated that the trust seems to continue as a discretionary arrangement after her death. 

If she is relatively young, with say another 20 years life expectancy then a medium risk balanced portfolio initially yielding say 4% could make sense, although there should be every possibility for the income to rise over the ensuing years. This might suggest a traditional portfolio of Investment trusts, corporate bonds, gilts as well as retail funds invested in these sectors could make sense. 

However, if the life tenant is somewhat older in poor health and appreciably lower life expectancy then a more cautious approach to the portfolio with maybe a greater weighting toward lower risk bonds, nsi products and the like,  might be called for.  Bear in mind, as trustees ( and as noted in the Farrer article ) you change your investment policy as circumstances dictate, so you can always pivot out of the lower risk approach on her death, for a more adventurous approach for the continuing discretionary arrangement for you and your bother.

There is no one size fits all in this situation, and your completion of the Investment Policy Statement (IPS) for the present, will ( in your case ) have  due regard to your stepmother's age and health. 

The fact that your discretionary investment managers are insisting on the IPS, tells me that they are alive to their obligations under the Trustee Investment Act 2000, and therefore need to be guided having regard to the variables I mentioned above.

Incidentally I assume the investment firm is a full service wealth manager that can directly access and implement stockmarket shares , gilts and corporate bonds, as well as retail investment funds?

Doubledhelix

Hi Poseidon, thank you for further thoughts - again very helpful in clarifying my thinking and understanding our options. A couple of clarifications: the trusts will end/be dissolved upon the death of our stepmother, who is in her mid-80s, in reasonably good health, with an independent income. I am minded to recommend a short-medium term investment policy with low risk profile to the other trustees. The fund manager is full service.

poseidon1

Doubledhelix said:

Hi Poseidon, thank you for further thoughts - again very helpful in clarifying my thinking and understanding our options. A couple of clarifications: the trusts will end/be dissolved upon the death of our stepmother, who is in her mid-80s, in reasonably good health, with an independent income. I am minded to recommend a short-medium term investment policy with low risk profile to the other trustees. The fund manager is full service.

Useful to know your stepmother's age and that she has independent income beyond the trust.

Given her age and that  the trust terminates on her death, I would certainly  support a lower risk investment profile weighted towards bonds, gilts etc with a short to medium term outlook as far as equities are concerned.  A 4% yield should be comfortably achievable on that basis without having  to top up her income with capital advances periodically.  

Bear in mind even if IHT is in point on her death, sale of the equities element may not be necessary if the bond/gilts/cash components suffice to meet the trust share of IHT. You and your brother can then retain the equities with the benefit of a CGT free uplift going forward. 

The investment manager's ability to buy Investment Tusts, gilts,  individual corporate bonds ( short and medium dated ) gives them that extra ammunition towards achieving  a well diversified portfolio to meet the trust objectives, something the typical IFA might struggle to replicate.

Doubledhelix

Thank you Poseidon1 - helpful as ever!