You may be wondering how trust funds work. You may be worried about someone who is too young, like a child, or not able to manage their own money. They may be a grandchild or a special needs relative or simply a loved one whom you want to offer certainty with respect to financial protection, life-long support, college education, and so on.
You may consider a trust fund as part of your Estate Planning, which in essence is how you want your assets, your house, your businesses, valuable possessions, money, accounts be managed when you pass away.
Truth being said, trust funds are quite complex legal structures and this is why you need to understand what they are and how they work in order to make sure that they serve you well in the exact purpose and manner you wanted them to.
The tax implications of a trust fund for both its creators and its beneficiaries are significant, so you better know how trust funds work.
What is a trust fund ?
A trust fund is in fact a legal entity. You may be more familiar with other types of legal entities such as limited companies, which are the one of the most common types of business.
So, a trust fund is a legal entity that is made up of assets or property hold on behalf or a person or an organization (also known as the beneficiary). As such, trust funds can be made up of money, real estate, bank accounts, various types of property, shares (also known as stocks), businesses, heirlooms, artworks and any other kind of investment. These assets can be released to their beneficiary only when certain conditions are met that have been established when the trust fund was constituted.
The person who initiates and creates the trust fund is called the Grantor or Settlor. The person on whose behalf the trust fund is created is known as beneficiary, as we mentioned before. The persons or organizations who are appointed through the trust fund to manage the assets are known as trustees.
The Grantor sets out what the assets are for which the trust fund is created and also determines how and when these assets will be managed on behalf of the beneficiary and how and when these assets will be released to the beneficiary.
The most common type of trust fund is conditional upon a beneficiary’s coming of age or upon a significant event in the life of the beneficiary, such as college graduation, marriage, issue of children, taking up of a certain profession and so on.
The most significant advantage of a trust fund is obviously the protection and correct management of the assets you wish to secure on behalf of the beneficiary.
While this may sound all good, there are some notable downsides: the setting up of a trust fund is costly, as you may decide to employ an Estate Planning attorney to get this done properly. However, once the trust fund is set up, you will receive tax benefits.
How to set up a trust fund ?
In order to set up a trust fund, you need to have a minimum of two trustees and a maximum of four. These should be people you know very well and trust implicitly. It is also possible to appoint an organization as trustee, such as a business, a bank or a law firm, however this may cost you substantially in trust fees.
You may consider the advice of a solicitor, because the wording of the trust fund has to be done right.
How about the taxes side of a trust fund ?
Well, with respect to the assets, once they become part of a trust fund, they are protected against bankruptcy, financial strains, family disputes, lawsuits and similar perilous events. This is because the assets are no longer considered as personal possessions of the Grantors.
With respect to taxes, there are several advantages in setting up a trust fund.
1. Capital Gains Tax: if you were to gift an asset to a family member, this may result in Capital Gains Tax (CGT) on you as person making the gift. CGT may prove quite costly if the asset you are gifting appreciates (increases in value overtime). However, if you place the same asset in a trust fund, the charges can be reduced significantly or even deferred in a manner that helps you save tax.
2. Inheritance Tax: Under existing legislation, it is possible for a husband and wife to put two times the nil rate Inheritance Tax (IHT) band (currently £650,000 in total) of value into a Trust every seven years without immediate inheritance tax costs. (The seven year period has to do with the fact that if you gift a relative but live longer than seven years after that, tax will start to be paid for the asset that was gifted).
However, that monetary value can be placed in a trust fund and thus protect it from inheritance tax for as long as the trust fund exists.
The amounts that can be transferred into a trust fund can be larger than £650,000 where certain business reliefs apply, or the person making the gift has surplus income. If the person making the gift survives for seven years after the gift is made, the value of the asset will not be included in their estate for inheritance purposes.
If they do not survive the period, exemptions may still apply. Increases in the value of the asset placed in the trust fund should continue to be protected from charges.
3. Income tax: It is possible to share income arising from assets held by the trust fund across the wider family, making use of their personal allowances and lower bands of income tax, without the Trustees losing control of the underlying assets held in the Trust.
There are quite a few different types of trust funds, depending on the purpose and need of the Grantor and Beneficiary and therefore how trust funds work varies accordingly. Please note that depending on the type of trust fund you have set up, there will be different rates of income tax applicable.
How can LAS Accounting Ltd help you ?
When it comes to navigating complex accounting areas such as taxes, you may find you want professional help. Spending less on tax means you have got more money to put towards your financial goals, and a financial adviser could help you put together a plan.
Now might be the ideal time to engage the services of an accountant to do all the work for you and provide you with all the tax advice you need.
Don’t hesitate to get in touch for any further enquiries at: firstname.lastname@example.org