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In basic terms, a trust is a legal structure where the legal and beneficial ownership of property is separated. Legal ownership rests with ‘trustees’ who hold the trust assets for the benefit of nominated ‘beneficiaries’. Trusts are usually designed with flexibility and protection of assets in mind. The person creating a trust is known as a ‘settlor’, or a ‘testator’ if the trust is established by will. There are a number of different types of trusts which are available for estate planning purposes.
A bare trust is not a ‘settlement’ for tax purposes but instead the trust assets are treated as belonging to the underlying beneficiary and will form part of their estate on their death. Bare trusts generally have limited usefulness other than making modest provision for minor children, or sheltering personal injury awards from means assessments for benefits purposes.
Discretionary trusts are the most commonly used type of trust for planning purposes. They enable the trustees to distribute income and capital from the trust at their absolute discretion. No beneficiary has any absolute entitlement to the trust assets. A letter of wishes can often be useful so that the trustees have some guidance as to the settlor/testator’s intentions.
Discretionary trusts fall into the ‘Relevant Property Regime’ for inheritance tax purposes and this will be examined in Part 2 of this article. Essentially however, they are taxable at higher rates for most taxes and are also subject to a charge to inheritance tax every 10 years.
Where a discretionary trust is established by will then any distribution made out of the trust within two years of the testator’s death will benefit from ‘reading back’ for inheritance tax purposes and so this adds to the flexibility and tax efficiency of the arrangements.
Any type of trust can in theory be used to provide for a disabled beneficiary but there is an express provision under Section 89 of the Inheritance Tax Act 1984 which can be availed of. Such a trust is often referred to as a ‘Disabled Persons Trust’ or sometimes a ‘Section 89 Trust’. In order for Section 89 to apply, during the lifetime of the disabled beneficiary any distributions from the trust must be applied for their benefit, save for some limited exceptions.
A disabled person’s trust will be treated as belonging to the beneficiary concerned for tax purposes but will still provide the protection of a standard discretionary trust. The tax treatment is simpler as a result.
An IPDI can only be created by will (not as a lifetime trust) and will provide that a nominated beneficiary – the ‘life tenant’ – will enjoy exclusive occupation of any trust property and/or to have the benefit of any income produced by it. This is often referred to as the ‘present right to present enjoyment`.
Many IPDIs are ‘flexible’ in the sense that they have overriding powers enabling the trustees to alter the life tenant’s interest at their discretion but that does not change the initial character of the trust as a qualifying life interest.
IPDI trusts are extremely useful as a will planning tool for married couples who have had previous relationships and want to provide for children from a previous marriage on the death of a surviving spouse. They also assist greatly with planning for long term care since the value of an IPDI is left out of account on any means assessment carried out in respect of the life tenant/surviving spouse under the Health & Personal Social Services (Assessment of Resources) Regulations (Northern Ireland) 1993.
These are special trust arrangements which apply exclusively under the will of a parent of a beneficiary who is under twenty-five at the date of their parent’s death. They are designed to avoid the Relevant Property Regime for inheritance tax purposes. It is important to note that it is only a parent who can avail of these trust options – it is not possible, for example, to create such vehicles for a grandchild or remoter issue.
Setting up a trust can be useful way of safeguarding your assets and providing for loved ones. If you would like to find out more about Trusts, or any of the issues raised in this article, please contact Michael Graham.
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This article has been produced for general information purposes and further advice should be sought from a professional advisor.