Setting up discretionary trust - is my understanding correct?

itwasntme001

My parents are looking to setup a trust to gift some money to grandkids.  I understand the differences between bare vs discretionary trust.  If the tax is not so punitive we would like to use discretionary given the control.

Obviously we will speak to a specialist(s) on this.  But from my understanding there is a way around the punitive tax charges so would be good to confirm my understanding is correct:

- The amounts to be gifted would be around £300k, from both grandparents, so the total nil rate band would be £650k (2 x 325k) currently, and 2x whatever nil band every 10 years.  So the initial and 10 yearly IHT charge and IHT exit charge, there will not be any initial charge, and there might be the other IHT charges if the value grows substantially in the future (more than double).

- The income tax charges are high for dividends/interest income.  My understanding is that if this income is paid out to the beneficiaries, the tax can be reclaimed to match the personal tax rate.  In the case of grandkids, because they are minors and have their full allowances, all of the tax paid by the trust can be reclaimed upto their allowances.  Additionally, since this will be income received by a minor, a bare trust account would need to be setup for the minor to recieve this money in.

- CGT tax is similar between discretionary and bare trust.

Initially we would invest the money in a global passive equity index and gilts (probably low coupon ones so more of the yield is capital gains which are free of tax).  As the grandkids reach adulthood, the proceeds will either be distributed or held in the trust and invested in on/offshore bonds given better tax efficiency as presumably the grandkids would be working etc.

poseidon1

Bare Trusts avoids the worse aspects of discretionary trusts, but at the expense of control and flexibility. Bare trusts cannot accommodate grandchildren not yet born and terminate when each beneficiary attains 18.

Discretionary trusts provide significant flexibility and can cover multiple generations within the limits of the  English 125 year perpetuity period ( unlimited perpetuity under Scottish Law ). 

The disadvantages are of course  tax , professional accounting and compliance fees. Trustee income tax at 45% is the big one if investing conventionally, although I note the intent to invest in passive global trackers and direct investments in low coupon gilts.  Yes, some or all the 45% rate can be recovered where trust income distributed to the non/low tax paying beneficiaries.   Trust income can accumulated over  the entire lifetime of the trust 21, but should avoid using accumulation unit trust investment funds for this purpose.

Re CGT, trusts pay the top rate for individuals, but with only half the exemption.

Annual accounting , record keeping, and tax compliance for theses forms of trusts is onerous and potentially complex so should be best left to a professional STEP qualified chartered accountancy firms.  As well to note their fees could impact significantly on income available for distribution. As for law firm involvement, their services best restricted to drafting and executing the trust instruments rather than any ongoing trust administrative function ( they are too expensive and not their natural skillset)..

As for IHT, you are correct in that on the anticipated £300k gift per parent there would be no initial charge unless death within 7 years. However, great care needed if your parents intend to make substantial outright gifts to their own children in addition to those in trusts. There is a certain order mixed gifting should occur so as not to extend the 7 year period ( when the trust falls out of their estates ) to 14 years. I will not go into the technical details as to how 14 years can be triggered, that is for the specialist adviser.

10 year anniversary IHT report will be mandatory. If the trust fund exceeds the joint NRB at that time ( currently £650,000), a 6% IHT charge is levied on the excess.  If the grandparents are minded, they could pay the 10 year charge but that would be treated as  new additional settled funds requiring another 7 year survivorship . There is a useful opportunity within 90 days after the anniversary to distribute trust capital to beneficiaries, free of IHT exit charges. However this opportunity does require meticulous planning to ensure it is not overlooked when the time comes.

Finally you mention investment bonds. These are very useful to minimise  accounting and tax compliance costs if utilised from outset rather than investing conventionally. However, by their nature they are not suitable for making income distributions to beneficiaries since they produce no distributable income, so are best for trusts which intend to accumulate in the intial years rather than distribute.

Your parents ability and willingness to provide for grandchildren in this way is to be applauded but it does come at some notable potential  cost in tax and administrative complexity, for as long as the trust is in exsistence.

If you are to become a trustee going forward, you may want to acquaint yourself with the format of  discretionary trust accounts  - they resemble annual company accounts in many ways.

LHW99

You are talking about a considerable amount of money from grandparents. Separately from any kind of trust, is there likely to be a need for any of them to require care in future? If so, I believe the LA can consider if there was deprivation of assets, and potentially look back many years.

If they are in good health it probably wouldn't be an issue (and I don't know enough to say if putting it in a Trust avoids the possibility). May be a point to raise with the STEP professional.

boingy

Just be aware of the ongoing costs of administering trusts. On top of normal accounting fees, every time something changes (legislation, trustees etc) there will be a solicitor's fee to pay and those bills can be significant. I'm a trustee of a discretionary trust and we've paid almost £20k in fees since the trust was formed in 2007. That's two trustee changes, one death, three bits of new legislation and some weasel words in the original trust that, viewed cynically, could be described as a guaranteed future earner for the solicitors. So make sure you find someone who will advise you about the long-term costs as well as the benefits.

The other aspect of trusts is that once exist they are very hard to dissolve. "Irrevocable unless you go to court" was how one advisor described ours. If we could rewind the clock we would not create the trust knowing what we know now.

itwasntme001

Thank you poseidon1 for your detailed and informative reply.  It is much appreciated.  It confirms my understanding of things, particularly around taxes.

itwasntme001

LHW99 said:

You are talking about a considerable amount of money from grandparents. Separately from any kind of trust, is there likely to be a need for any of them to require care in future? If so, I believe the LA can consider if there was deprivation of assets, and potentially look back many years.

If they are in good health it probably wouldn't be an issue (and I don't know enough to say if putting it in a Trust avoids the possibility). May be a point to raise with the STEP professional.

Given my parents wealth, they will most likely not need the money, in fact I am convinced they will not need it, but of coruse you never know for sure.  Deprivation of assets will thus not be an issue as any care should be covered entirely by their wealth.  Plus they are 70 and in good health so I guess won't be an issue after sometime anyway.

In the worse case of them needing it, because the trust will be built up over time as well, via excess income gifting, this gifting can always cease if need be.

itwasntme001

boingy said:

Just be aware of the ongoing costs of administering trusts. On top of normal accounting fees, every time something changes (legislation, trustees etc) there will be a solicitor's fee to pay and those bills can be significant. I'm a trustee of a discretionary trust and we've paid almost £20k in fees since the trust was formed in 2007. That's two trustee changes, one death, three bits of new legislation and some weasel words in the original trust that, viewed cynically, could be described as a guaranteed future earner for the solicitors. So make sure you find someone who will advise you about the long-term costs as well as the benefits.

The other aspect of trusts is that once exist they are very hard to dissolve. "Irrevocable unless you go to court" was how one advisor described ours. If we could rewind the clock we would not create the trust knowing what we know now.

Thanks for this.  We had a discussion together as a family and we now feel, on balance based on everything I have learnt about trusts, setting up a bare trust account for grandchildren is best way forward.  We understand the risks, being at 18 years old having access to that kind of money can be risky.  But speaking to people by far the majority of this sort of situation does not end up badly at all.  Especially since the parents will have positive influence and good school access too.  The other thing is that there is a potential for a lot more wealth to be passed onto the grandkids when they are young so at 18 to handle this amount of money could be a very valuable lesson for larger amounts and general financial responsbility.

Cus

Without wanting to pry into your specific circumstances, the above numbers are similar to a scenario I am involved in.  May I ask, what is the benefit (tax and control) versus giving the money now as a gift (with potential IHT risk), or giving directly to the grandchildren when they pass away ( and taking the IHT potential hit)

Edit: in simple terms, generally speaking 

itwasntme001

Cus said:

Without wanting to pry into your specific circumstances, the above numbers are similar to a scenario I am involved in.  May I ask, what is the benefit (tax and control) versus giving the money now as a gift (with potential IHT risk), or giving directly to the grandchildren when they pass away ( and taking the IHT potential hit)

Edit: in simple terms, generally speaking 

Sorry don't understand your question?

Whether you give money directly or via a trust, it is all gifting, and there is no IHT after 7 years.  Although for dis trusts there are IHT charges for the trust itself.

AKW

boingy said:

Just be aware of the ongoing costs of administering trusts. On top of normal accounting fees, every time something changes (legislation, trustees etc) there will be a solicitor's fee to pay and those bills can be significant. I'm a trustee of a discretionary trust and we've paid almost £20k in fees since the trust was formed in 2007. That's two trustee changes, one death, three bits of new legislation and some weasel words in the original trust that, viewed cynically, could be described as a guaranteed future earner for the solicitors. So make sure you find someone who will advise you about the long-term costs as well as the benefits.

The other aspect of trusts is that once exist they are very hard to dissolve. "Irrevocable unless you go to court" was how one advisor described ours. If we could rewind the clock we would not create the trust knowing what we know now.

Boingy, that is exactly my concern. I assume the law firm were trustees in your trust. Have you looked into replacing them as trustees?