How to Set Up a Trust and Avoid Inheritance Tax

Trusts have become an integral part of financial planning, and the introduction of inheritance tax on pensions makes it an opportune time to consider establishing a trust to protect your assets and reduce tax liabilities.

What is a Trust?

A trust is a legal arrangement where assets are managed by a trustee on behalf of a beneficiary. It involves three parties: - Settlor: The person who establishes the trust and contributes assets. - Trustee: The individual who manages and distributes the assets. - Beneficiary: The recipient of the trust's assets.

How Do Trusts Work?

The trustee has the responsibility to oversee the trust and ensure that the assets are distributed according to the settlor's wishes. Trustees can be family members, friends, or professionals.

Types of Trusts

There are various types of trusts, each with its own purpose and characteristics: - Bare Trusts: Simple trusts with no restrictions on distribution. Beneficiaries receive capital and income once they reach a specified age. - Discretionary Trusts: Flexible trusts that give trustees control over distribution. They can determine who receives payments and how often. - Discounted Gift Trusts: Trusts that allow the settlor to gift assets while retaining income. The value of the gift is discounted based on future income payments, reducing inheritance tax liability.

How to Set Up a Trust: A 7-Step Guide

1. Define Goals and Choose Trust Type: Determine the objectives of the trust and select the most suitable type. 2. Appoint Trustees: Choose trustworthy individuals to manage the trust. 3. Specify Assets: Identify the assets to be placed in the trust. 4. Identify Beneficiaries: Name the individuals or organizations who will receive the trust's assets. 5. Draft Trust Document: Create a legal document outlining the terms of the trust. 6. Open Bank Account: Establish a bank account for the trust. 7. Fund the Trust: Transfer the identified assets into the trust.

Trusts and Taxes

Trusts can reduce inheritance tax liability by removing assets from the settlor's estate. If the settlor survives for at least seven years after transferring assets to the trust, the assets will be exempt from inheritance tax. However, a 20% tax may apply when setting up a trust that exceeds the nil-rate band. Trusts can also protect pensions from inheritance tax by allowing assets to be transferred into a discretionary trust. The trustees can decide on the distribution of income and capital, providing flexibility for managing assets across generations.

Example: Using a Trust to Avoid Inheritance Tax

Bryony Lewis's trust, established by her grandparents, has allowed her parents to retain control over the distribution of assets. The trust helps her make large purchases and will eventually benefit her children by providing funds for education or homeownership.

Conclusion

Trusts offer an effective means of protecting and managing assets, reducing inheritance tax liabilities, and providing long-term financial security for families. By carefully considering the objectives, selecting the appropriate trust type, and following a structured process, individuals can establish trusts that meet their specific needs and aspirations.