Trusts - How They Can Protect Loved Ones Following Death

October 2019
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HMRC has recently reported a reduction in the number of trusts established. This reflects a longer-term trend [1].  Are trusts a thing of the past or do they still have relevance to financial planning within the family? Here we look at how trusts can protect loved ones through difficult times such as bereavement, divorce and business failure and provide support for members of a family.

Taxation of Assets on Death

When someone dies their assets, less debts, form their estate. Lump sum gifts, not covered by exemptions, made in the previous 7 years are added back into the estate. If valued at more than £325,000 inheritance tax may be payable on the balance. Assets left to a spouse or civil partner are exempt from inheritance tax. Some assets such as farmland, or shares in private businesses are also exempt in certain circumstances but most other assets and valuables are included in the estate.

If the estate includes a residential property, which is left to a direct descendent, an additional £150,000 of the property value may be left tax free (unless the total estate is valued at over £2million). Where the deceased was a widow or widower, they may also use any unused part of their spouse’s allowances. Any value after allowances and exemptions is usually taxed at 40%. 

Life assurance can be arranged to cover the expected tax bill but unless it is placed in trust, it will form part of the estate and so the life assurance payment could add to the tax due, leaving a potential shortfall. Life policies must  be placed in trust so that the proceeds can be paid free of inheritance tax. A trust can also distribute money without the need to wait for probate.

Probate Delays

Before the estate can be distributed, the executor appointed in the will, or administrator in intestacy (where there is no will) must report all the assets and debts in the estate to HMRC, pay any tax and apply for probate. This can be a long process and can leave families unable to access the deceased’s assets or sell investments.

It is advisable to make separate provision for the costs likely to arise in the immediate aftermath of a death and to place funds outside of the estate, to keep the family afloat for at least 6 months. Family members who pay funeral costs and legal fees  can reclaim them from the estate. A life policy placed in trust could be used or a capital sum gifted to a trust, although the latter would be classified as a capital gift, which could be added back into the estate within 7 years of the date of gift.

Provision for Dependents

Trusts are vital for families in which partners are not legally married or civil partners. Cohabitants have no inheritance tax exemption and no right to inherit assets if there is no will or trust. The trust enables funds to be left to the dependents outside of the estate. If funded by life assurance, the payment will usually be tax free, if funded via cash gifts inheritance tax may be due if the gift to the trust was made within 7 years of the date of death and if, together with other assets, the estate exceeds the nil rate band (£325,000) and other available allowances

Sometimes trusts are established to retain control over the timing of the distribution of capital and income to  beneficiaries. This may be for tax efficiency. It may also be to protect the funds from the effects of divorce or bankruptcy of a beneficiary. Trusts can be used as a way of leaving funds to vulnerable beneficiaries, for example, a minor, or someone with learning difficulties or an addiction. The person setting up the trust can specify to the trustees how and when funds should be distributed.

Pension Plans

Since 2015 one of the most tax efficient ways to leave money to loved ones has been to pass on private pension plans, these do not form part of an individual’s estate, as they are usually arranged in a trust and in most cases are free of inheritance tax. Our blog Passing Pensions On explains how different pensions are treated after death of their owner.

Kay Ingram
Director of Public Policy, LEBC

Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. The contents of this blog are for information purposes only and do not constitute individual advice. A pension is a long-term investment. The fund value may fluctuate and can go down. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.  If you are unsure of the suitability of any investment or product for your circumstances, please contact an adviser. All information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation, are subject to change. The Financial Conduct Authority does not regulate estate planning, tax advice, wills or trusts.

[1] HMRC Statistics, show 149,500 trusts registered in 2017-18, 6% down on previous year and 29% down over 12 years. FT Adviser 30.09.19 Advisers champion value of trusts as numbers decline.

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