2 common myths around trusts that people often believe, busted

18 March 2023

If you are a parent, it is likely that you have thought about how much money you would like to pass down to the next generation, either now or in the future.

Something you may not have considered, though, is how this wealth will be transferred from you to your loved ones – and most importantly, whether this will be an efficient way to pass these funds down.

There are several ways you could do this, including making tax-efficient annual financial gifts, purchasing assets in another person’s name, or simply leaving money in your will when you pass away.

One wealth transfer vehicle you may have considered is trusts. These can offer several benefits for those wanting to transfer wealth efficiently, but sadly, many people believe myths about trusts that could mislead their choices.

Keep reading to find out two often-believed myths about trusts, along with the truth behind them.

1. “Trusts are only for the extremely wealthy”

The first misconception around trusts that many people believe is that trusts can only be established if you are extremely wealthy.

You may typically hear about trust funds being set up by the ultra-rich in order to finance their adult children’s lavish lives, but in fact, anyone could set up a trust and reap the financial benefits of doing so.

Instructing a solicitor to set up a trust may cost around £1,000, and there could be some ongoing fees – but the bottom line is that trusts are not only for those with generations of wealth behind them.

Trusts are designed to provide the following structures and benefits to both you (the settlor) and your beneficiaries:

• Ringfencing funds for specific purposes and within certain time frames. Trusts allow the settlor to designate money to be given to their beneficiaries at certain times (such as when they turn 30), and for specific purposes (like paying for a home).
• Reduce the amount of tax you and your loved ones may pay. As you will read in the next section, trusts can be extremely tax-efficient, especially if you are leaving a large inheritance in trust.

The specific benefits and efficiencies you and your family could experience depend on the type of trust you establish, how much wealth you place into it, and several other factors. It may help to discuss setting up a trust with your financial planner before you proceed. We can provide bespoke guidance on the type of trust that may work for your circumstances.

Just remember: anyone can use trusts as efficient vehicles for transferring wealth, so if you are beginning to look at your estate plans more carefully, considering a trust may be very helpful.

2. “Trusts are tax-free”

When looking into trusts, it is essential to make the distinction between “tax-efficient” and “tax-free”.

The phrase “tax-efficient” describes any financial structure, like a savings account or pension, that could help you to reduce tax – but crucially, that does not mean that no tax will be due on the money you place into it.

The same is true for trusts. There are several types of tax to be aware of when setting up a trust; here are two to look at in more detail.

Inheritance Tax

You may reduce the amount of Inheritance Tax (IHT) due on your estate by placing some or all of your taxable wealth in trust.

Assets within a trust are usually valued 10 years after the trust is set up, and every subsequent decade afterwards. When these valuations take place, an IHT charge of 6% may be applied to the amount above the nil-rate bands (the amount under which you can pass down assets without IHT being due).

Once you pass away, the wealth in the trust that exceeds the nil-rate bands is then normally subject to a 20% IHT charge, rather than the usual 40% rate. If you pass away fewer than seven years after establishing the trust you’ve set up for loved ones, the normal 40% rate, or a tapered rate, could be applied.

These rules vary depending on the type of trust you have, the type of assets you hold within the trust, and for how long you have held them.

Consulting a financial planner when setting up a trust may help you to clarify how much IHT could be due on the assets you are including.

Income Tax

If your beneficiaries receive an income from the trust you set up, they may pay Income Tax on the amount that the trust pays to them.

It is especially important to pay attention to Income Tax on trusts if your beneficiaries receive other forms of income, such as from employment, as these two streams of income could cause them to enter a higher Income Tax band.

It may also help to look at who is responsible for paying Income Tax on different types of trust. For instance, bare trusts place the responsibility of paying tax on the beneficiary, whereas discretionary trusts require the trustee to oversee the tax liability.

In any case, discussing tax on trusts with your financial planner could be constructive. This way, you may not fall prey to easily believed myths about trusts being “tax-free”, while also understanding the potential tax benefits of placing wealth in trust.

Get in touch to explore trust options with an experienced financial planner

If you are considering placing wealth in trust for your loved ones, get in touch with our experienced team of financial planners today. Email info@depledgeswm.com or call 0161 8080200.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate trusts, estate planning or tax advice.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.