Can you avoid tax with a trust? HEATHER ROGERS debunks some common myths

Heather Rogers is the founder and owner of Aston Accountancy and This is Money’s resident tax expert.

One of the most common misconceptions I encounter in my professional life has to do with trusts. There are many misunderstandings about how they work and the tax implications.

There seems to be a widespread belief that if assets are transferred to a trust there will be no tax to pay. Unfortunately, this is not usually the case.

Here I will go over the main types of trusts, how they work, what they are used for and the ways in which they can be beneficial, to dispel some of the myths.

What is a trust?

In a trust, the assets are managed by a person or persons called trustees, for the benefit of another person called beneficiary or beneficiaries.

The person who puts the assets in the trust is called the trustor. When a trust is created, there is usually a trust deed or will that will determine how the assets are managed.

The trustees are responsible for the assets of the trust. They manage the trust, prepare tax returns, pay tax obligations, and decide how best to invest or use the trust assets.

Assets can be land and property, shares and cash.

Why put assets in trust?

The typical reasons for establishing a trust are the following:

– Protection of family assets;

– Someone is too young to manage their affairs;

– That the person is incapacitated and cannot manage his affairs;

– The settlor wants to transfer the assets during life or after death in a way they can control.

Assets can be transferred to a trust while someone is alive in a lifetime trust or after their death through a testamentary trust.

Almost all trusts must be registered with the trust registration service.

Let’s look at some of the most used trusts.

Naked trusts

This is the simplest form of trust. The trustees guard the assets until the beneficiary reaches the age of majority.

The beneficiary is entitled to all income and capital once they are 18 years old (16 in Scotland).

A transfer of assets to a simple trust does not give rise to an inheritance tax charge for the settlor and the trust assets will form part of the beneficiary’s estate, not the settlor’s.

Therefore, the settlor’s estate does not have to pay any inheritance tax.

Income and gains are taxable to the beneficiary regardless of age, unless:

– One of the beneficiary’s parents is the settlor and the income exceeds £100 per annum, in which case it is taxed on the parent;

– The settlor or his or her spouse retains an interest, for example by receiving income from property held in the simple trust.

Interests in possession trusts

They are usually created upon death. The beneficiary receives any trust income immediately directly from the trustees, or the use of assets held in trust, but cannot control the assets themselves.

The income they receive may be income from a rental property or dividends from shares in a company, but the beneficiary has no rights to the property or shares that will pass to a third party, for example, the settlor’s children.

If the income is allocated to the beneficiary (meaning it goes directly to him), then income taxes will apply to the beneficiary.

Otherwise, the trustees will pay taxes: 8.75 percent on dividend income and 20 percent on anything else.

Sometimes there is no income other than the right to use the asset, for example the family home for the surviving spouse during his or her lifetime, but the home passes to the children when the spouse dies.

This is often used to protect children from disinheritance, should the surviving spouse remarry.

The assets would still be in the settlor’s estate for inheritance tax purposes.

Discretionary trusts

A discretionary trust is exactly that. The trustees have full control over the assets and income generated by them and decide how and when to deliver the income and assets to the beneficiaries.

Depending on the trust deed, the trustees can decide:

– What is paid to the beneficiaries (can be income or capital);

– To which beneficiary or beneficiaries to make payments;

– How often payments are made to beneficiaries;

– Any conditions to be imposed on the beneficiaries.

One use of this trust could be for a grandchild who may need more financial help than other beneficiaries at some point in their life, and also for beneficiaries who are not capable or perhaps not responsible enough to handle money on their own.

Often, grandparents establish the trust with the parents as trustees.

Sometimes they are used to protect family assets.

Trustees pay income taxes; The first £1,000 is taxed at the same rates as holding interest trusts and the remainder of the income is taxed at 39.35 per cent on dividend income and 45 per cent on all other income.

For inheritance tax purposes, things are more complex. Because beneficiaries, by the very nature of the trust, have no rights to the trust fund itself, it generally does not form part of your estate in the event of divorce, bankruptcy, or death.

Because of these advantages, depending on the amount placed in the trust, there is often a tax charge on assets brought in, decadal charges, and exit charges when assets leave.

However, a settlor can transfer up to the £325,000 nil rate band (£650,000 for a couple) every seven years without an entry charge, provided they have not used any part of their nil rate band previously within the last seven years in similar transfers. .

If the settlor puts more than this into the trust, then he or she will pay a 20 percent tax on the excess. If the settlor dies within seven years, he may have to pay more taxes.

If the discretionary trust is created in a will, all assets will be taxed in the normal way for inheritance tax. There is no saving on inheritance tax. However, no additional charge will be applied to assets placed in trust.

Ask Heather Rogers a tax question

Tax expert Heather Rogers answers our readers’ questions

Heather Rogers, founder and owner of Aston Accountancy, is our tax columnist. She is ready to answer your questions about any tax topic: tax codes, inheritance tax, income tax, capital gains tax and much more.

If you would like to ask Heather a tax question, email her at taxquestions@thisismoney.co.uk.

Heather will do her best to respond to your message in an upcoming monthly column, but will not be able to respond to everyone or correspond privately with readers. Nothing in her answers constitutes regulated financial advice. Posted questions are sometimes edited for brevity or other reasons.

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If Heather can’t answer your question, you can Learn how to get help with your taxes here. including sources of free professional advice if you are elderly and/or low-income.

You can also contact money helper, a government-backed organization that provides free assistance to the public in financial matters. Their number is 0800 011 3797.

Heather provides tips here on how to find a good accountant, including when to seek help, hiring the right type of firm, and typical costs.