Trust in your future

Getting ready for changes that govern certain types of trusts

From 6 April this year there are important changes to the tax rules governing certain types of trust. If you are running a trust created before 22 March 2006 it is important that you do not miss out on this opportunity. The background to the transition period formed a part of the biggest change to the inheritance tax (IHT) rules in a generation, in the 2006 Budget.

To allow a period for certain existing trusts to adapt to the new environment, a two−year transition period was introduced during which trustees could amend certain aspects of a trust before new rules applied. If you are a trustee of a trust which might be affected by these changes, do not miss out on this last chance to make changes before April 5.

The first trust affected is known as "interest in possession", which means a trust where certain beneficiaries have a right to income. Sometimes the income beneficiary is known as the life tenant. In financial services, these are called "flexible trusts."

The consideration here is whether to change the beneficiary currently entitled to income. If this change is done before April 5, the change will be implemented under the old rules and the trust does not fall into the new regime. The new post 6 April regime would involve a potential IHT charge of up to 6 per cent every 10 years and a proportionate charge of up to that figure when capital is paid out to a beneficiary.

You might want to change an income beneficiary where, for example, that beneficiary becomes financially secure and no longer requires access to the trust fund. That beneficiary might want to reduce their estate with one eye on a potential IHT bill, since in this type of trust the underlying trust value was aggregated with the beneficiary’s estate for IHT purposes.

It could now be more appropriate for the children or grandchildren of that beneficiary to be in the frame. In terms of the IHT planning for the outgoing beneficiary, after seven years the value of the trust interest which they no longer enjoy falls out of their estate. Trustees are therefore likely to be taking into account the relative wealth and needs of different generations.

The outcome in many cases will be that the trustees take no action as there is no current requirement to change the income beneficiaries.

The trustees here have the comfort of knowing that the trust will generally continue to operate under the old rules even beyond 6 April 2008, as long as the income beneficiaries do not change.

The second category of trust affected is accumulation and maintenance (A&M) trusts. These trusts are more significantly affected since, unless a specific change is made before 5 April 2008, they will fall under the new rules after that date. Basically, under the new rules, A&M trusts must pay out capital to beneficiaries at age 18, otherwise they will incur a tax charge.

Many existing A&M trusts provided for capital to be paid out at age 21, 25 or even a higher age, so the trustees of pre 22 March 2006 A&M trusts have to consider whether a change of age is appropriate, necessary or indeed possible.

A change might not be appropriate if there are significant assets within the trust and the age of 18 seems too young to receive large sums of capital. Here, the trustees might prefer to pay the IHT charge of up to 6 per cent every 10 years for the advantage that the trust assets remain within the trust until the beneficiary is older, giving better asset protection. Alternatively, a concessionary option for A&M trustees could be to opt for an 18−25 trust where a reduced IHT charge of up to 4.2 per cent could apply if an age up to 25 is selected.

A reduction to the age of 18 might not be necessary if the value of the trust assets is below the nil−rate band, meaning no IHT liability would arise. Finally, a change might not be possible if something in the trust deed prevents it.

Levels and bases of, and reliefs from, taxation are subject to change.