Individuals can make an unlimited number of gifts to family members and other individuals during their lifetime without incurring an upfront inheritance tax (IHT) charge.
Provided that the donor survives seven years from the date of the gift, it will also become completely free from IHT on death.
Outright gifts, however, result in the loss on control over the assets gifted away. Those assets can also be subject to various risks in the hands of the recipient such as claims on divorce, cohabitant claims, creditors and claims on death.
An alternative to making an outright gift of assets is to instead gift assets to a trust. This allows for assets to be held on behalf of an individual, or a number of individuals, without passing over full control. Depending on the type of trust created, it can also provide complete protection from the risks noted above.
What is a Trust?
A trust is a legal relationship between three parties:-
- The individual or individuals who establish and add assets to the trust (known as the “trusters” or “settlors”)
- The parties appointed under the Trust Deed to hold the trust assets for the benefit of the beneficiaries (“the trustees”)
- The individuals named in the trust deed as being entitled to benefit from the trust assets (“the beneficiaries”).
Once assets are transferred to a trust, the trustees become the legal owners of those assets. Subject to the provisions of the Trust Deed, the trustees exercise full control over the assets and make all decisions regarding distributions to the beneficiaries.
It is possible for an individual to be more than one party within the same trust. For example, a settlor could retain an element of control over assets given away by also becoming a trustee. A settlor could also set up a trust in which they are included as a beneficiary. However, there are tax implications of setting up these types of trusts which must be taken into account.
How do I set up a Trust?
A trust is ordinarily governed by a document known as the Trust Deed. This sets out the terms of the trust and who the beneficiaries will be.
A bespoke Trust Deed is prepared for each trust and this is signed by the settlors to establish the trust. It is also possible for settlors to put in place a Letter of Wishes to provide further guidance to the trustees.
Once the Trust Deed is signed, the settlors can transfer cash or assets into the trust and these will be held by the trustees for the benefit of the beneficiaries.
Adding Value to a Trust
Except where reliefs are available, the maximum value of assets that can be added to a trust without incurring an upfront IHT charge is the available ‘nil rate band’ of each settlor (currently £325,000 for each individual less any chargeable gifts made during their lifetime).
Settlors can then make use of certain IHT reliefs and the “seven year refresh” of the nil rate band to add additional value to a trust over time.
Distributions from a Trust
The rights of a beneficiary to income or capital payments from a trust will depend on the type of trust established and the terms of the Trust Deed. For example, it is possible to specify a fixed age at which the beneficiaries will receive assets from the Trust or this can be left to the discretion of the trustees.
There can be IHT, Income Tax and Capital Gains Tax consequences of making distributions from a trust but there are also ways to utilise the beneficiaries’ own tax allowances to make tax efficient distributions and reduce the overall tax liability of a transfer.
How we can help you
If you would like advice on how to set up a trust in Scotland, contact a member of our specialist team today.