Will Your Lifetime Trust Backfire And Cost You Thousands Of Pounds?8th Jul 2020
Twenty years ago, discretionary trusts were all the rage among families that were worried about Inheritance Tax (IHT) both during their lifetime and in their wills.
Large numbers of people (not just millionaires) set up these trusts as a way of moving money out of the estate for tax purposes.
They did so because rising property prices were pushing their estates over the IHT threshold. But in 2007 the government announced it was closing a tax loophole.
And so the families lost interest in their trusts. But those abandoned trusts could come back to haunt them – and cost them huge sums in tax.
Why You Should Set Up A Discretionary Trust
Trusts can be set up for many reasons – not simply as a way of minimising tax. They can be used to ringfence money to ensure the financial security of children too young to make financial decisions for themselves.
A discretionary trust can also help to protect the family estate from spurious inheritance claims. In this day and age more wills are being contested. Often it is only when both parents are deceased that issues regarding a lifetime trust or a will trust come to the fore.
If a trust saves tax legally and with the approval of HMRC, then fine. But that should be a secondary benefit – not the sole or primary purpose of the trust.
How Two Lifetime Trusts Cost A Family £230,000
One family ended up with a £230,000 tax bill because the two lifetime trusts it set up both backfired.
The two trusts were created to give members of the family more control of who would receive what when the parents passed away.
This allowed the father (via letters of wishes) to change his mind frequently about how much his children would receive in bequests, depending on which child he favoured most at any given time.
So the trusts were not set up solely for the purpose of minimising IHT liability. Though, in my experience, that benefit is never far from the minds of those setting up a trust.
So far so good. But here’s what went wrong…
How An Abandoned Lifetime Trust Can Backfire
Every trust has trustees – and they must hold regular meetings to manage the trust. Ideally, those meetings should be held at least once a year. Otherwise HMRC may think the trust is merely a sham.
However, since the tax loophole closed in 2007, many trustees have stopped meeting. They lost interest in lifetime trusts now they are less tax efficient.
And that can have devastating consequences…
In the £230,000 tax liability case, the parents set up two lifetime trusts (one each). The children were among the trustees. But even though they were the children of the deceased, they lost their tax allowances because they received the gift in their capacity as trustees and not as direct descendants.
They were caught between the terms of will and trust. They would:
- receive bequests from the will in the normal way
- not gain tax benefits from the trusts – because the government closed the loophole (and the trustees had done little with the trusts since)
- lose their normal tax allowances because they were trustees
- face a much higher tax bill – £230,000 (in their case).
What Should I Do About My Lifetime Trust?
Get expert legal advice from wills and probate solicitors with specialist knowledge of trusts. Do not delay.
You will need to review your trust(s) and will(s), whether you are a:
- settlor – the person putting assets into the trust
- trustee – a person managing the trust
- beneficiary – a person who will benefit from the trust.
You may have forgotten about your old lifetime trust but it could still serve a useful purpose. It can help to safeguard assets for generations to come. A trust also offers special IHT reliefs on business or farm properties.
But this is a complex area of the law. You will need advice on whether your assets would be better protected by the trust or by a nil rate tax band, depending on your circumstances.
Setting Up And Managing Trusts During Covid-19 Lockdown
Lockdown is easing but it still pays to take precautions – especially if you are older or in another high risk category.
We can hold meetings using phone or video calls. Just the other day I was involved in a meeting of trustees via video; it included:
- the client and two other family members – all in the same room (but each on a different screen)
- a stockbroker working from his conservatory
- an independent financial adviser working from his office
- an accountant in a separate room
- me, working from my office in Poole.
These meetings are very easy to organise and are extremely efficient. They will save your trust money because they reduce travelling time.
Trusts documents can be signed in our office carparks using social distancing measures. You need never leave the quarantine safety of your car. Trusts are easier to sign and witness than wills because they need only one witness. (Wills need two witnesses).
Get Expert Legal Advice
When was the last time you reviewed your will? When did you last look at your trust documents or hold a meeting of trustees? It pays to:
- review your will every few years
- hold a meeting of trustees at least once a year.
This is important because it helps to ensure that everything is correct and that your wills and trusts still meet your requirements.
Get expert legal advice from Coles Miller Partner Stuart Bradford, head of the firm’s Probate Department.