My mother made a discounted gift trust of £50,000 in January 2004 in favour of my brother and I as beneficiaries. At the time, she was 79 years old. She is now approaching 93. Initially, she took a £2,000 annual income from the trust, but cancelled this after four and a half years. The trust is now worth £114,000. I’m wondering what taxation my brother and I will face if the trust is disbanded either when my mother dies or while she is still alive.
The trust fund could have been set up as an absolute trust or a discretionary trust. It is important to find out which one it is as this affects the charges you may face if you access the money.
If your mother set up the trust as an absolute trust, she will have nominated you and your brother as beneficiaries and stated the share of the trust fund you can benefit from.
All capital growth on the trust investment will be immediately outside your mother’s estate. Unlike other trusts, the trust itself will not be subject to an exit fee of up to 6% when the capital is removed from the trust, or at the 10-yearly anniversary, and each beneficiary’s share of the trust fund will be treated as forming part of you or your brother’s own estate.
Currently, details of an absolute trust do not need to be reported to HMRC. As your mother has survived for seven years after making the gift, it qualifies as a potentially exempt transfer (PET). This means that the trust fund will be free of inheritance tax upon your mother’s death.
Where there is a gain on a surrender or part-surrender of the investment, an income tax charge arises. The gain is treated as income of the beneficiaries and charged at their highest rate in tax years after the death of the settlor [the person who sets up the trust].
The beneficiary can take out up to 5% of their original investment each year without paying tax straight away, up until the full amount of the original investment has been withdrawn.
If the fund was set up as a discretionary trust, when money is paid out of the trust to you or your brother, while your mother is alive or after her death, the capital transferred out of the trust is subject to an exit charge of up to 6% of the transfer. As the fund was set up more than 14 years ago, the PETs and chargeable lifetime transfers won’t be brought into charge and so the fund will fall outside your mother’s estate.
With a discretionary trust, if the beneficiaries are alive and resident in the UK when an income tax liability arises, or it occurs in the tax year in which they die, it will be treated as part of their income and they will have to pay any tax due. They may recover the tax from the trustees.
If it arises after their death (other than in the tax year in which they die), or when they are not resident in the UK, the tax charge will be assessed against UK resident trustees.
I encourage you, therefore, to find out from the fund manager what type of trust the investment is held in.
The tax rate applicable to trusts over £1,000 is currently 45% and will remain at this rate in the 2018/2019 tax year. For many bonds, the charge takes into account the tax already paid within the bond, regarded as equivalent to 20%, so the trustees will pay the difference between this and the 45% trust rate. The charge will be met from the trust, rather than by the trustees personally.
Moneywise says: This is all extremely complicated and we recommend that you get independent professional financial advice.