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Everything you need to know about Trust Planning - The Good, the Bad and the Ugly



When trust planning is being discussed, too much focus is sometimes placed on the tax situation without fully understanding the actual requirements/personal circumstances of those involved.


Tax mitigation is of course very important, but it isn’t everyone’s objective. Our experience is that most trusts are used to avoid Isle of Man Probate and facilitate simpler succession planning.


So, what’s good about trusts, where can things go bad and what happens where ugly situations arise that were never considered or anticipated at outset?


The Good




Where a plan is held in trust and the last surviving life assured dies, the deceased’s estate does not have to provide a company like RL360 with Probate to enable them to release the policy proceeds. This is because the trustees are the legal owner.


Probate avoidance demonstrates the effectiveness of trusts at their most simple level, but they are also used for tax mitigation strategies by transferring assets outside of an estate or for succession/ inheritance tax planning.


But (and this is a really big but!) they only work if they are set up correctly, the right trust provisions are used and all involved know what they can and more importantly can’t do. Trust planning can become a millstone around the neck of those involved if mistakes are made at outset.


So what type of things can go wrong?


The Bad




Settlor Domicile and residence


Overlooked, these two factors alone can have significant implications on the effectiveness of the trust going forward. For example, if the client is UK domiciled, the creation of the trust can result in a charge to UK Inheritance Tax (UK IHT) and furthermore, there are usually restrictions as to how much they can benefit from the trust in order for it to be effective for IHT.


Alternatively, if the Settlor is not UK domiciled, the last thing they probably require is unnecessary access restrictions.


Have the succession laws in the Settlor's country of residence been considered?


For example, civil law jurisdictions may look through trusts where the provisions seek to deprive heirs from inheriting property under local succession laws or where local taxes can be avoided.


Selecting the correct trust provisions


If the objective was simply to avoid Isle of Man probate, then it would be overkill to set up a trust where access to the trust capital was restricted. Alternatively, a probate trust is useless where IHT planning is concerned as the assets never leave the Settlors estate.


Fixed or flexible beneficiaries?


Whilst a Settlor may only want fixed key individuals to be able to benefit from the trust, they need to be mindful that absolute rights are created for those individuals and that should they fall out with a the beneficiary, there is little they can do to deprive that individual of their share.


For that reason, having the flexibility to select beneficiaries from a range of individuals or classes can be very useful where there are concerns over financial maturity, unsuitable marriages or failed business ventures.


Access


To be effective for IHT mitigation, there must usually be some restriction placed on the amount of access the Settlor has to the assets placed in trust.


If there is unrestricted access, the IHT planning will usually fail as nothing has been given away.


Where IHT planning and access are required, a Loan Trust or Discounted Gift Trust (DGT) can be useful, but they are both totally different. The Loan Trust allows unrestricted access to the original loan and any outstanding amount can be recalled by the Settlor at any time. The DGT on the other hand creates an income for life which cannot be changed. Therefore, if income is not required, needs to be reduced or cannot be spent, DGTs may not be the right option.




The Ugly




At the start of this article we looked at areas which make trusts such good structures for planning etc. However, things can go terribly wrong and, where they do, the courts must sometimes get involved.


What if the trustees don’t act in the best interests of the beneficiaries?


In Cowan v Scargill and others, the trustees of the UK’s National Union of Miners pension scheme had political motives which made them uncomfortable with investing the fund in certain assets even though it was the right thing to do. The court ruled that the trustees could not make a decision based on their own political agenda and that they had a duty to the beneficiaries to obtain the best return possible, irrespective of whether or not it was against the personal morals of the trustees.


Beneficiaries enforcing the trust


In Saunders v Vautier, assets were placed in trust for Vautier with the intention that he would not receive them until he was 25. Vautier was not particularly happy about this and, at 21, suggested that the trustees should wind up the trust and give the assets to him now.


The court agreed with his suggestion on the basis that although he was only 21, as sole beneficiary he was going to get everything anyway.


This situation highlights the difficulties that can arise with fixed beneficiary trusts, as insistent individuals can potentially de-rail the objectives of the Settlor.


Trustee mistake


There is a longstanding rule called the ‘Hastings Bass Principle’ which granted trustees a get out of jail free card if they undertook a particular course of action, and that action had unintended consequences – usually tax.


Over the years HMRC became quite frustrated with the court's willingness to set aside the actions of the trustees where they claimed a mistake had been made and, following the decisions in Futter v Futter and Pitt v Holt, they were successful in restricting its application.




In Summary


It is important that the trust selected is aligned to the objectives of the Settlor and that all parties are aware of what they can or cannot do.


RL360 has a number of tools available that can help you select the most suitable trust and all our draft trusts contain comprehensive guidance notes and case studies.


Our trust selection tool

Trust range overview