In the first of this series of articles, we discussed trusts and how they provide a method of making gifts for the benefit of others. These are put into the safe hands of trustees, who look after the assets, providing income or benefits to beneficiaries until it’s appropriate to close the trust. Trusts can be very useful for inheritance tax (IHT) purposes, but this isn’t the only tax that makes them appealing.
Income tax benefits of trusts
Trusts can be hugely beneficial for income tax purposes in the right circumstances. If a trust is not settlor-interested (ie where the settlor, their spouse/civil partner or their minor children can benefit), then payments made to a beneficiary from that trust are taxed at their marginal tax rate. This means lower tax-paying beneficiaries may have little to pay.
An example of this is when grandparents settle trust funds for their grandchildren. Assuming the grandchildren have no other income, payments of up to £12,570 can be made for their benefit with no net tax paid. This can be a very efficient way of funding school fees.
Parents usually need to wait until their children are over 18 to create a trust for their benefit without adverse tax consequences. A gift into a trust could be made where the income is used for university fees – again at a tax-free or low tax rate.
Once the children or grandchildren finish education, the trust capital might be used to help towards a new home or held in trust to generate income or for future beneficiaries.
Capital gains tax benefits of trusts
One potential issue with creating a trust is having the cash resources to make a gift. However, the tax rules can help with this.
Assets can be gifted directly to a trust rather than sold to raise cash – and subsequently attracting capital gains tax (CGT). CGT hold-over relief is used to defer the gain. Any CGT is then payable by the trustees instead when they come to sell in the future.
This works well for rental properties and long-standing shareholdings where the gains on a disposal could be high. As long as the assets produce an income stream for the trustees to use and no disposal is required, the trust could continue to hold them.
Trustees have a CGT annual exemption, which is half that of an individual. Therefore, if we take the example of a shareholding, the trustees could slowly divest themselves of the shares using their exemption each year and diversify away from the gifted shares.
Another benefit is that if the trustees decide to distribute capital to a beneficiary, they can do this under the same hold-over rules. A further planning option is distributing shares to a beneficiary with no other gains. The beneficiary can then sell the shares and use their full annual exemption.
An example
The life of a shareholding trust
As an example of the life of a trust, a grandparent might do the following:
- Create a trust with £300,000 of shares, with any gain ‘held over’.
- Use the income and some capital for the following 10 years to pay £20,000 per annum towards school and university fees, with little or no income tax or CGT required to be paid if within the relevant allowances.
- After 10 years, assuming some growth, there might be, say, £270,000 left in the trust for the two grandchildren who have now left university.
- Each grandchild could have £135,000 towards a property purchase or provide additional income until they need the capital.
By this stage, the grandparent has made a gift of £300,000 which (along with any growth) is now outside their IHT estate. They have not paid income tax on, say, £100,000 of income over that period and have helped their grandchildren. This assumes roughly 3% growth and 3% gross income being generated.
The total tax saving for additional rate taxpayers here could be over £160,000 in IHT and income tax, plus any CGT savings, compared to making payments from after-tax income, or over £200,000 by doing nothing at all – all from a £300,000 gift.
Can we help?
Trusts come with set-up costs and may require ongoing work to prepare accounts and annual tax returns, but they can be a very powerful and beneficial tool if used correctly.
Be aware that The Chancellor has announced an Autumn Budget for 30 October 2024, and this may include tax changes relating to trusts, inheritance tax and CGT.
At Shipleys, we can provide trust and estate planning advice, arrange for a trust to be created and provide ongoing guidance. For will trusts, we can arrange a suitably worded will to be drawn up to create a trust on death and offer probate and trust services. Visit our page on the Shipleys website to learn how we help with trusts and estates.
Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary. Please talk with your usual Shipleys contact or get in touch with one of our specialists shown on this page.
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