Pilot trusts |
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Scott Walker writes about pilot trusts
A pilot trust is a lifetime discretionary trust established with a small initial sum (typically £10). It would be usual to set up a number of such trusts. Assets are then added to the trusts at a later stage, which could be during a person’s lifetime or on death i.e. by a Will.
Pilot Trusts are useful in saving inheritance tax for future generations. Inheritance tax is still paid on the estate of the person who has died. The ‘nil rate band’ i.e. the amount that can be left before inheritance tax is payable, is £325,000 at present. However, by establishing a series of pilot trusts, each trust will have their own ‘nil rate band’ for inheritance tax purposes. In effect it is possible to benefit from multiple nil rate bands when dealing with tax charges to trusts.
The first steps would be to set up a series of discretionary trusts (as mentioned above). These trusts can be set up with a small sum of, say, £10 each. Often these trusts are executed on consecutive days. The trustees and beneficiaries of the trusts can be (and usually are) the same, but each settlement should be given a different name ('Mr Smith's No 1 Trust', 'Mr Smith's No 2 Trust' etc) so that they can be individuated. It is essential that each of the trusts is actually constituted: a trust will not be properly constituted until the property which is being settled is in the hands of the trustee. So it is not enough to recite that £10 is being settled; rather the £10 must actually be transferred to the trustee. It will be important to ensure that proper records are kept evidencing the fact that the payment has been made.
Then, once the trusts have been properly constituted, the will can be executed. The will itself needs to provide for a series of gifts to each of the pilot trusts. So, for example, a testator i.e. the person making the Will, might wish to settle assets to the value of £750,000 on the five pilot trusts. The will then needs to provide for a gift of £150,000 to be paid to the trustees of, and held upon the terms of, each of the named trusts.
Here is an example:
Mr Smith’s wife died in 2008. Mrs Smith's whole estate was left to Mr Smith. Mr Smith's estate is now worth about £600,000 and he has made no lifetime transfers of any value. Mr Smith has about 20 great-nieces and great-nephews for whose benefit he wishes to leave his estate. He wants his whole estate to be settled on a discretionary trust for them. Mr Smith might simply provide for a settled gift in his will i.e. leaving his whole estate on a discretionary trust for his great-nieces and great-nephews. The value of the fund is within the transferable nil rate band (£650,000) i.e. Mr Smith’s nil rate band of £325,000 and his wife’s unused nil rate band of £325,000.
Therefore, there will be no inheritance tax charge on his death. But only the single nil rate band (i.e. £325,000) will apply to the future charges in respect of the trust. The value of the fund exceeds the single nil rate band and so there will be a charge to inheritance tax on the ten-year anniversaries and exit charges on assets leaving the trust more than two years after Mr Smith's death.
Instead, Mr Smith might create three pilot trusts before executing his will. By his will, Mr Smith then leaves a third of his estate to each of the pilot trusts i.e. £200,000 to each trust. His great-nieces and great-nephews are the beneficiaries of those trusts. Each trust, therefore, enjoys its own full nil rate band and the value of the assets in each trust is comfortably within the nil rate band.
There is therefore no charge to inheritance tax on the ten-year anniversary of the trusts or when property leaves the trusts. It is possible to create a greater number of pilot trusts for larger estates. However, it should be borne in mind that creating a large number of such trusts would bring with it a potentially expensive and onerous administrative burden. It is possible after a person’s death, however, for the pilots trusts to be merged into one ‘trust’ without compromising their inheritance tax effectiveness.
November 2012
Disclaimer:
A pilot trust is a lifetime discretionary trust established with a small initial sum (typically £10). It would be usual to set up a number of such trusts. Assets are then added to the trusts at a later stage, which could be during a person’s lifetime or on death i.e. by a Will.
Pilot Trusts are useful in saving inheritance tax for future generations. Inheritance tax is still paid on the estate of the person who has died. The ‘nil rate band’ i.e. the amount that can be left before inheritance tax is payable, is £325,000 at present. However, by establishing a series of pilot trusts, each trust will have their own ‘nil rate band’ for inheritance tax purposes. In effect it is possible to benefit from multiple nil rate bands when dealing with tax charges to trusts.
The first steps would be to set up a series of discretionary trusts (as mentioned above). These trusts can be set up with a small sum of, say, £10 each. Often these trusts are executed on consecutive days. The trustees and beneficiaries of the trusts can be (and usually are) the same, but each settlement should be given a different name ('Mr Smith's No 1 Trust', 'Mr Smith's No 2 Trust' etc) so that they can be individuated. It is essential that each of the trusts is actually constituted: a trust will not be properly constituted until the property which is being settled is in the hands of the trustee. So it is not enough to recite that £10 is being settled; rather the £10 must actually be transferred to the trustee. It will be important to ensure that proper records are kept evidencing the fact that the payment has been made.
Then, once the trusts have been properly constituted, the will can be executed. The will itself needs to provide for a series of gifts to each of the pilot trusts. So, for example, a testator i.e. the person making the Will, might wish to settle assets to the value of £750,000 on the five pilot trusts. The will then needs to provide for a gift of £150,000 to be paid to the trustees of, and held upon the terms of, each of the named trusts.
Here is an example:
Mr Smith’s wife died in 2008. Mrs Smith's whole estate was left to Mr Smith. Mr Smith's estate is now worth about £600,000 and he has made no lifetime transfers of any value. Mr Smith has about 20 great-nieces and great-nephews for whose benefit he wishes to leave his estate. He wants his whole estate to be settled on a discretionary trust for them. Mr Smith might simply provide for a settled gift in his will i.e. leaving his whole estate on a discretionary trust for his great-nieces and great-nephews. The value of the fund is within the transferable nil rate band (£650,000) i.e. Mr Smith’s nil rate band of £325,000 and his wife’s unused nil rate band of £325,000.
Therefore, there will be no inheritance tax charge on his death. But only the single nil rate band (i.e. £325,000) will apply to the future charges in respect of the trust. The value of the fund exceeds the single nil rate band and so there will be a charge to inheritance tax on the ten-year anniversaries and exit charges on assets leaving the trust more than two years after Mr Smith's death.
Instead, Mr Smith might create three pilot trusts before executing his will. By his will, Mr Smith then leaves a third of his estate to each of the pilot trusts i.e. £200,000 to each trust. His great-nieces and great-nephews are the beneficiaries of those trusts. Each trust, therefore, enjoys its own full nil rate band and the value of the assets in each trust is comfortably within the nil rate band.
There is therefore no charge to inheritance tax on the ten-year anniversary of the trusts or when property leaves the trusts. It is possible to create a greater number of pilot trusts for larger estates. However, it should be borne in mind that creating a large number of such trusts would bring with it a potentially expensive and onerous administrative burden. It is possible after a person’s death, however, for the pilots trusts to be merged into one ‘trust’ without compromising their inheritance tax effectiveness.
November 2012
Disclaimer: