Tax planning will always form part of the advice process. Simply by making a decision as to whether you should invest via a pension scheme, an investment bond (onshore or offshore), a Unit Trust, a Maximum Investment Plan (MIP) an ISA or any mix of these you are committing your funds to a form of tax treatment that will have its particular pros and cons. It may be preferable to consider an option that is exempt from Capital Gains Tax or, on the other hand, a client may prefer to minimise income tax liability and use his GGT annual allowance to realise gains without generating an immediate tax bill.
We will make recommendations as to how you should apportion your assets between the various tax wrappers to minimise the erosion of your wealth, taking into account annual limits and allowances, whilst bearing in mind that there is a point at which it becomes inadvisable to sacrifice flexibility and accessibility. As a rule, tax-efficiency comes at a price, usually in the form of restricted access to the investment although sometimes the only downside is the limitation to investment amounts imposed by law, such as the £20,000 annual ceiling on ISA contributions.
We prefer to take advantage of non-controversial tax mitigation structures, such as ISAs, Investment Bonds or Pension schemes. We know that, providing the investment operates within the rules applying to these types of tax wrapper, it is unlikely that they will be subject to challenge. These types of investment are also prudent options for many other reasons beside tax efficacy.
We become more circumspect when tax mitigation is required to be the sole driving force behind a recommendation. Products with the facility to avoid tax as their only raison d’etre can make poor investments and we are reluctant to recommend poor investments where their only purpose is to keep a portion of the funds out of the coffers of the exchequer. Sometimes the very best form of tax planning can be to pay the tax, or make provisions to pay it. This applies particularly to Inheritance Tax, which is where good old-fashioned life assurance comes in.
Trusts are frequently recommended as estate planning vehicles for avoiding the lengthy tentacles of HMRC. This may be so but by putting funds out of the reach of the taxman you may also be putting them beyond your own grasps. Often this is only identified as a problem when a previously unanticipated need to access them becomes urgent. It is also a myth that establishment of a trust will forever deprive HMRC of all access to the investment income of the trust.
We will be pleased to offer a view on any trust arangements you are considering and make our own recommendations. It is always wise to inject a healthy air of common sense and scepticism into the arena of tax planning. It is a fairly safe bet that if the proposed solution offers total tax avoidance with ready access to funds, regardless of how serpentine the access route, then it probably won’t work and could ultimately cost more than the original tax bill.
The following is a summary of the main forms of trust that might play a part in estate planning, as extracted from HMRC’s own guide, with a brief comment on their defining features:
The beneficiary has an immediate and absolute entitlement to both capital and income in the trust. Beneficiaries will have to pay Income Tax on income that the trust receives. They may also have to pay Capital Gains Tax and Inheritance Tax.
Interest in possession trusts
With interest in possession trusts, beneficiaries have a right to all trust income but not usually capital. Taxation can be at varying rates and can be complicated.
Discretionary or accumulation trusts
A discretionary trust is one where trustees have ‘discretion’ about how to use the income of the trust, and sometimes the capital. An accumulation trust is one where the trustees have the power to accumulate income (add it to capital). A trust may give trustees the power to do both.
Mixed trusts are a combination of more than one type of trust. For tax purposes the different parts of a mixed trust are usually treated according to the tax rules that apply to the respective parts.
A settlor is someone who ‘makes a settlement’ – by placing money or other assets in a trust. Usually this is done for the benefit of someone else, but sometimes the settlor may benefit from the trust. When this is the case, the trust becomes a ‘settlor-interested’ trust.
UK trusts may be set up or managed by people living abroad. The tax rules can be extremely complicated.
Trusts for vulnerable beneficiaries
Special tax rules apply for trusts set up for disabled people or children who have lost a parent.
Heritage, charitable or business-related trusts
These can include sinking funds, employee share schemes, heritage and maintenance trusts and others.