Working Together in Prosperity

Many people think they are boring, inflexible and complicated. Perhaps you do too. However the truth is that they can be a highly effective way of reducing tax and increasing the efficiency and flexibility of your assets. The key is to get your head around the almost archaic jargon used in trust literature construction. So let's simplify matters.

To show you how useful and effective trust planning can be we are going to use apple trees to illustrate how they work. In the same way as a bank account pays interest, or a share portfolio pays dividends or a property pays rent, your tree gives you regular benefits or income, in the form of apples, every year.
You may have many apple trees in your orchard or simply one big one. You can build different types of fortress around them to protect them from the attacks of the greedy tax man armies. These fortresses can also have different special doors to let in the people you choose to pick the apples or even to take the whole tree. In some fortresses you can even put a time lock on the door.
The following pages provide eight reasons for setting up a trust:

Reason No.1 - save up to £96,800 in tax (*tax year 2001/2002) Good enough reason?
Did you know that everybody is entitled to save £96,800 in tax on their assets when they die for the tax year 2001/2002? This reflects the allowance to which we are all entitled by the Inland Revenue to deduct - £242,000 - from the value of all our wealth tree assets in our orchard before paying inheritance tax on death. The jargon used for this is the 'nil rate single band'. (Gobbledegook provided courtesy of the tax man this time and not the lawyers!)
It is because of this 'jargon' that so many of us fail to take advantage of this allowance and instead our families are left to write out big cheques to the tax man when really it is our children that we would want to benefit. The sad thing is, it really is quite easy to make sure the tax man gets as little of your orchard fruit as possible. You just need to build the right fortress around it (trust).
Ida and her husband, Eddie have assets in their orchard representing a total value of £484,000. In fact they have only one very large apple tree in their orchard. What happens if Ida and Eddie, like most of us, are too bored by trusts to do anything about them? Situation 1: No trust planning
The apple tree is split equally in two, £242K for Eddie, and £242K for Ida. So what happens when Eddie dies?
Well, all his share of the apple tree goes to Ida and thankfully there is no tax to pay as assets passing to spouses on death are tax free. Aha - but what happens when Ida dies?
£242K comes under the nil rate band and so goes to Kelly and Davina free of tax. Unfortunately, this leaves a balance of £242K that is subject to IHT at a rate of 40%! So the greedy tax man helps himself to £96,800 from Ida's estate, with the remaining £145,200 also going to the kids. Interestingly, if there were four children, each would receive an inheritance of £96,800 - exactly the same as the tax man is getting! Do you really want to adopt the Chancellor of the Exchequer as your fifth child? No? So why let him get a whacking £96,800 of your hard earned wealth?
Situation 2: Some simple trust and estate planning (fortress building)
This time, Ida and Eddie have unravelled the gobbledegook with their financial adviser and as a result, have successfully completed some simple fortress building (trust and estate planning). The fortress will ensure that on death, each of their inheritance tax free allowances are used. So, the maximum number of trees and apples in their orchard pass through the doors of the fortress - controlled by them - to their children without the Chancellor getting his greedy hands on them. (In gibberish, this is their nil rate band.)
This time when Eddie dies £242K goes to Kelly and Davina and £242K goes to Ida.
By ensuring that Eddie's allowance (nil rate band) is used on his death, his £242K comes out of the orchard estate through the fortress doors completely free of IHT - instead of simply passing it directly to Ida.
£242K (another IHT-free allowance) goes to Kelly and Davina.
So the tax man gets nothing! Everything Eddie and Ida have worked for throughout their lives is passed on to their children, with the greedy tax man getting nothing. So sorry Chancellor, its back to the orphanage for you in this case I'm afraid.
So, lets just recap a bit...
 

Reason No.2 - Give some of your apples and trees away and yet still be in control (OR, 'How to keep your apples and trees away from the greedy tax man').
PETs, taper relief and stuff (in other words - jargon alert)!
Ida is concerned that, when she dies, the value of the wealth trees in her orchard will be such that the greedy tax man will take a sizable bite of them. However, she has heard that something called a PET might be of some help to her.
So, let's look at this PET thing in more detail, before seeing how it could help Ida
Ida decides to give £50,000 to each of her daughters, Kelly and Davina. Total gift is therefore £100,000. So this £100,000 is a potentially exempt transfer (PET). If Ida now lives for seven years then the full value of the transfer (£100,000) will not raise an inheritance tax charge. Therefore no apples or trees for the Chancellor! What happens if Ida dies only two years after having made the PET or gift?
The PET 'fails'. What this means is that the full 100% value of the gift would be included in her estate. This uses up part of her nil rate band and leaves the rest of the estate that is in excess of the nil rate band subject to inheritance tax - so sadly, lots of apples and trees for the Chancellor.
Ida's friend, Maggie, who is wealthier than Ida makes a gift of £442,000. So assuming that the nil rate band remains the same, and she dies after six years then the amount that is in excess of the nil rate band, £200,000 is subject to inheritance tax at 40% (i.e. £80,000). Taper relief however means that inheritance tax at 40% is only payable on 20% of the excess (i.e. £40,000 x 40% = £16,000).
So we can see that PETs are really quite simple things that can prove very useful in protecting the value of your orchard from the greedy tax man. The story which follows demonstrates how, by putting the gift (or PET) inside a fortress (or trust) you can not only potentially reduce your tax charge but you can also still control the timing of when your beneficiaries actually receive their share of the money.

Reason No.3 - Avoid legal difficulties over inheritance plans.
(Ensure all your wishes are carried out and that all the people who are meant to benefit, do.)

Reason No.4 - Minimise administrative hassles.
(No time is wasted after your death while your family try to work out who should deal with your estate. The chosen beneficiaries can receive their inheritance immediately.)

Reason No.5 - Minimise taxes on income and/or capital gains*.
(For example, Any of your non tax-paying beneficiaries can reclaim tax if they are awarded an income from your estate.)

Reason No.6 - Generation skipping; allowing children/ grandchildren to benefit from wealth.
(A tax efficient way of passing wealth on to future generations.)

Reason No.7 - To provide cash to pay for unavoidable IHT on the deceased's estate.
(This can be avoided by placing a life assurance policy in trust.)

Reason No.8 - Confidentiality
(The contents of a settlement are not available to the public - unlike wills.)
Convinced? Good! So how do you do it...

The Settlor

I own this tree - which represents the part of my orchard which I want to gift to my children. I want to do this now because if I give it up on my death this tree may form part of my estate. That means that the tax man may take a branch (or limb or two) in inheritance tax before it reaches my children (in step 2). At the same time I'd still like to retain some control over the apples even after I've given my tree away. A trust can let me do exactly that - give away my asset now but I still maintain some control. If you like, having my apple cake and eating it too. As the person who is creating this trust or building this fortress, I am technically known as the settlor.
As the settlor of the trust I must now appoint the trustees (or keepers of my fortress) and the beneficiaries - those who will get my trees when I can no longer look after them.

The Trustee - no not a friend of the jailer in 'Prisoner Cell Block H'

This is my sister Tesa. I'm going to appoint my sister as the trustee or keeper of the fortress. If I wanted I could also be a trustee or I could appoint more than one trustee but in this case I'd prefer to leave this responsibility to my sister.
Effectively the legal ownership of my tree now belongs to Tesa as the trustee. It is her duty to nurture the tree and distribute the fruits growing behind the protective fortress of my trust - for the benefit of Kelly and Davina (the eventual beneficiaries).
In this case I've set up the trust (or fortress) so that the trustees (keepers) must look after the tree within the fortress itself but the apples will be passed out equally through special windows to my two children who are the beneficiaries.

The Beneficiaries

As the beneficiaries, and under the terms of this trust, my children are entitled to all the apples that grow on the tree.
Had my apple tree been a portfolio of investments the 'apples' or fruit of this gift could have been the income dividend cheques, or had it been a fixed income bond or a cash investment it would have been interest payments.
Of course I could build my fortress (trust) in a number of different ways. For example, I could have simply set it up so that its keepers would release the tree from behind its fortress and give all its fruit entirely to both my children at a predetermined age or date in the future by simply adding a timelock to the front door.
Or I could have set up the trust in such a way as to give my sister - as the trustee and keeper - considerable flexibility in determining when, or if, my children should receive benefits from the trust.
The point is that there are a number of different options in front of me when I am setting up the trust or fortress to protect my wealth and in the remainder of this presentation I will take you through the options available to anyone considering setting up a trust today.

The Protector

There is one final, optional, person involved in setting up a trust or fortress - the protector. The protector can be anyone I choose to select, my husband for example. However, in this case I will set myself up as the protector of the trust - a perfectly legitimate option.
As the protector of the trust I become the supreme commander of the fortress. This position effectively gives me an overall power of veto over the actions of the keepers of the fortress - the trustees. This makes sure that I (or whoever I appoint as the protector) can watch over the trustees and the trust to ensure that it is being administered and maintained in accordance with my wishes.

So there we have it - I as the settlor (owner), appoint my sister as the trustee (fortress keeper), to look after the apple tree for the benefit of my two children (the beneficiaries), and I as protector (fortress commander), I have an overall watch on the entire proceedings from my lofty tower.

As I mentioned in the last section there are a number of different options open to me when I am setting up a trust fortress around my orchard assets. Depending on how much flexibility or the type of benefits I want to give away there are some basic choices open to me. In addition to wills, there are a handful of basic trusts in the UK and we are going to look at four of the most common - each with their own particular form of flexibility and tax advantages. Another jargon alert required I'm afraid, but don't worry - all will be explained.

Absolute or Bare Trust
Accumulation and Maintenance Trust
Discretionary Trust
Interest in Possession Trust

It is important to make sure you select the correct trust at the outset. Arguably it is one of the most important decisions when it comes to effective trust planning or fortress building. You should always seek professional advice from your solicitor or an independent financial adviser before proceeding.

Absolute or Bare Trust
As with many trusts an Absolute or Bare trust puts a fortress around your wealth (and no, it does not conceal a nudist colony on the inside!). It effectively allows you to give away your tree assets from your own orchard estate. This means the greedy tax man will identify all your wealth tree assets in this case as a potentially exempt transfer, (So a PET is not really for life after all!) If you then live for a further seven years, it may not form part of your own estate for inheritance tax purposes. An absolute trust is often used to gift assets that parents don't need to their children. Unfortunately an absolute trust has one major disadvantage. Not only is the trust inflexible but the beneficiaries have an 'absolute' right to the full use of the assets when they reach age 18. Hence the name 'absolute'.
So in effect, whilst the trust places a fortress around the assets, the main gate has a time lock on it set for when the beneficiaries turn 18, at which point the door (and indeed the walls) come tumbling down - and your wealth tree is totally exposed to the elements - or in this case, your children.

Accumulation & Maintenance Trust
An Accumulation and Maintenance trust has some favourable tax treatment and flexibility. It is sometimes called a 'Childrens trust' and quite frankly, should ALWAYS be called this because, for once this meets the 'Ronseal' test and 'does exactly what it says on the tin'. It is designed for parents or grandparents who want to support their children or grandchildren.
This means that this particular wealth tree from my orchard of assets is now outside of my estate (after seven years - remember that PET lesson?) and can be used for the benefit of my children. However, unlike a Bare or Absolute trust the walls do not come tumbling down when my children reach 18. Furthermore, whilst my children have to be the beneficiaries, I do not have to say exactly how much goes to which child at the outset. The trustees have discretion over how much (if any) they receive from the trust and the trustee can wield the axe over the tree trunk, branches, and apples to distribute them as they see fit.
A restriction of this trust is that it only works if income from the trust is used for the 'education, maintenance or benefit' of the children, or kept within the trust. It must do this otherwise it does not qualify for this type of fortress protection. One final point to note is that the trust usually comes to an end after 25 years. So the fortress could 'collapse' automatically at the end of 25 years. Beneficiaries must become entitled to income, if not capital, no later than 25 years after creation but thereafter the trust could then continue as an Interest in Possesion trust.
I've set up my Accumulation and Maintenance fortress trust for Kelly and Davina and again, I also want Tesa to act as the trustee. The apples plucked from the tree within the fortress have to be used to pay for Kelly and Davina's education otherwise the fruit remains within the walls of the trust. That's what 'accumulation' means - the apples are effectively stockpiled. When Kelly reaches the age of 18, my sister Tesa, as the trustee and fortress keeper, decides not to give Kelly any more apples but continues to give some to Davina - she has that flexibility.
At the end of the fortress trust - remember it can end after 25 years - Tesa as the trustee has absolute discretion over how she cuts up the apple tree and divides it between the beneficiaries. So assuming that Kelly has now married the apple addict from the previous story, Tesa can decide to give the entire tree to Davina. Once again Tesa as the trustee and fortress keeper has that flexibility with this trust or fortress design.
As you can tell by comparing the last two examples, an Accumulation and Maintenance trust, or Childrens trust can be more flexible than the Absolute or 'strip the tree' Bare at 18 trust. However, it is still quite restrictive in the sense that the beneficiaries must be grandchildren of a common grandparent and any income or gains are charged to the settlors (by definition the parents).

Discretionary Trust
Our third type of trust is your 'flexible friend' in the world of trust design! In this case the trustees or fortress keepers have full flexibility over who gets benefits, when they get benefits, what benefits they get and how much benefit they get. Once again the trust design builds a fortress around my apple tree and this secures it outside my estate for inheritance tax purposes. There is no real time lock on the door this time.
In fact only Tesa as the trustee or fortress keeper has a key to the fortress door and therefore access to the tree and the apples. She is the one who decides who benefits and when.
Tesa can decide to give fruit to Kelly as income, saw off a branch from the tree (capital) and give it to Davina, or indeed anyone else she believes should benefit from the trust - obviously, subject to my role as the protector/fortress commander of the trust - we can't have her getting too power-mad!
This is very useful as whilst I have gifted the wealth tree out of my orchard estate and I no longer have control over it, I can be sure that Tesa (and myself as protector) can still exert a great degree of control over who gets the tree and its fruit. So now we can ensure that although Kelly is married to an 'apple addict' that she will get no benefit from the tree or the apples. BUT...(didn't you just guess there was a 'but' on the way!)
Unfortunately, this flexibility comes at a price! Whilst the flexible fortress is secure from all outsiders and only the trustees have the key, the tax man has a special skeleton key which lets him in on a regular basis. (Greedy Chancellor again!) In fact, when you set up a Discretionary trust the tax man automatically takes a substantial chunk (20%) of the value of the tree and continues to levy tax charges every ten years!
Its almost like finding out you have named the tax man as one of the beneficiaries. But as I said before, I am quite sure I do not want the Chancellor as a surrogate son!

Interest in Possession Trust
You might be forgiven for thinking this is the money made from drug dealing. However, this perhaps is the most interesting - and in my view - beneficial of the four trust designs we shall examine. Once again it places my wealth tree within a fortress and keeps it outside my estate and out of the reach of the tax man after the seven year PET requirement. Most important however, is that there are no special tax charges here!
Our apple tree is now locked away safely within the walls of the Interest in Possession trust fortress. The interesting aspect of this particular trust however, is the access arrangements.
The trustee and keeper of the fortress, Tesa, has access to the wealth tree and can pay branches and apples out to whomever she decides they should go subject to the rules of the trust and also my role as protector. This means Tesa can pass fruits from the tree out on a discretionary or flexible basis.
On the other hand, the income or apples must be paid automatically out of the fund to the beneficiaries i.e. Tesa has a lot less flexibility here. Therefore the trust can be a rather good way for me to give away the apples whilst still preserving the tree and ensuring that Kelly and Davina benefit from the income. Of course, the original problem still remains in that Kelly will automatically have her right to income or apples from the fund (which may be substantial) and neither Tesa or I can do anything to stop it.
So an Interest in Possession trust is almost a halfway house between the previous two trusts, providing considerable flexibility over the tree (capital) without a tax charge, but less flexible when it comes to the income of apples. If only there was a way of having the flexibility we have over the capital tree and similar flexibility over the apple income? That way Tesa and I could ensure that the capital tree could be used as we saw fit, but we could stop Kelly from giving away her share of the apple to her pip of a husband!

I'm sure you remember from our previous lessons on the types of trust available that flexibility comes at the cost of higher tax charges. For example, an Interest in Possession trust allows me to have considerable control over my capital (wealth tree), but the cost for this is that the trustee or keeper must pay out any income (apples) to my daughters and the tax man also automatically takes a big chunk with the prospect of more going his way in the future. Wouldn't it be fabulous if I could have control over these last two elements too?
Well maybe there is! There is a way of keeping all the income within the trust fortress so that no apples are paid out. I could do this by wrapping my wealth tree gift within an offshore life bond - or greenhouse.

Let's say I want to give a 'unit trust' to my daughters (fancy name for a wealth tree) and I set it up inside an Interest in Possession trust fortress. As previously, Tesa has the freedom to pass out branches and apples to the category of beneficiaries I have set out as the Trustee (or keeper). There are two potential problems here - Tesa still needs to pass out the apple income to both Kelly and Davina as it is made and neither I, nor Tesa have any control over that. The second problem is that the tax man is still going to take a huge chunk of this in special tax charges.

In this case, all the income (apples) are contained and reinvested within the unit trust as fertiliser - in other words the offshore life bond is a 'non income producing asset'. No apples leave the greenhouse at all so there is no 'income'. So if there is no income, it can't be passed automatically to Kelly and I have managed to cut off a potential source for her apple-guzzling husband! Things are looking up!
And what of the tax man? Well, some of the 'stricter tax treatments' which are usually applied to apple bearing assets such as my tree, no longer apply when the apples are not being awarded. So although I can't cut the Chancellor out altogether, (though I will keep on trying) at least I can limit the amount of my hard earned apples he can take!

So now that our tree is protected by the greenhouse, within the fortress, I have full control over the tree and I don't have to worry about apples automatically being paid out, because there are no apples, only fertiliser and growth!
Now, whenever Tesa wants to pay out some money from the fortress, she simply does this by taking some of the new apples from the tree top inside the greenhouse. In jargon speak this is 'withdrawing some of the growth on the capital from the offshore life bond'.

So which type of greenhouse should you choose?
The offshore life bond I pick could be one of the unique bonds from Scottish Life International - they have a 'Secure Investment Portfolio' (SIP) and a 'Protected Investment Management Service (PIMS)'. Both of these bonds allow you to hold a wide range of investment funds. Indeed the PIMS bond can hold almost any unit or investment trust and all the income from either of these investments are kept within the bond and are considered non-income producing by the greedy tax man.
Like my tree which pays me apples most investments will pay an income of some description - bonds will pay a coupon, shares will pay dividends (hopefully!) and property will pay rental income.
However, where the investments are funds within a life assurance bond, any income generated will be automatically reinvested in the life fund or using our analogy, the apples never leave the greenhouse and only help the tree to grow. In this case there will be no income payments (or apples flying out of the fortress windows), only capital growth. This explains why life assurance policies are classified as 'non-income producing assets' or in our case, non-apple producing apple trees.

So this means that you can wrap your investments within a life bond and then wrap your life bond within your Interest in Possession trust - or to use our analogy enclose our apple tree in a greenhouse and then put a fortress around the greenhouse.
But the brilliant part is that as the bond does not pay any income (apples), the income beneficiaries do not actually receive anything. (Had there been any income or apples, the beneficiary would have been entitled to get it.) Therefore, the Interest in Possession trust fortress is largely transformed into a flexible capital trust with excellent tax and administrative advantages.
It's no wonder that life companies tend to provide packaged trust arrangements which are simply life bonds wrapped in an Interest in Possession trust. Or in other words life offices provide greenhouses to shelter your apple trees before you build your fortress around them.
BUT... (don't worry this is a good 'but') there are a number of other advantages of using an offshore life bond. Obviously it is absolutely crucial that your apple tree has as many opportunities to grow and as few threats as possible to enable it to grow and provide for you and your family.

Tax

Administration

Risk


Or, as we like to say, TAR. The TAR content of your apple tree could seriously damage your wealth and it is worth looking at how these factors could affect your investment apple tree.

Tax
With most investments held outside a life bond, income tax, capital gains tax and ultimately inheritance tax on death are the big threats to eating away at your money. The Chancellor loves to eat away at not only your apples but the tree itself and has devised a number of ways of getting at both the tree and the fruit.

Income tax
Income tax is usually levied on investment income (apples) and any interest on deposits as it rises. This can impair and restrict the growth of your tree and your portfolio over the long term. By taking small bites out of every apple the Chancellor like most parasites can do long term damage. BUT... (and it's another good 'but') an investment held within an offshore life bond, or tree within a greenhouse, doesn't have this problem as the investments grow largely free of tax. In effect the greenhouse ensures your tree is free of parasites.

Capital gains tax
Capital gains tax can also reduce the growth potential of your investment porfolio or apple tree, because as soon as one type of fund is sold, perhaps to invest in another or to switch out of an investment that you think is about to fall, any capital gains will be taxed at your highest marginal rate. Or in other words should you decide to do some gardening around your apple tree or rearrange some of the branches or fruit - the Chancellor will go with you and tax you whenever you make a change! (He's certainly not the 'green' Chancellor!)
OK this sounds very complicated and I'm sure the Chancellor is happy for you to feel intimidated about the tax treatment of capital gains, But... (don't worry there's another good 'but' coming up). For investments under the capital gains tax regime, gains are charged at 10% if income plus gains are within the starting rate income tax band. Gains are charged at 20% if income plus gains fall within the basic rate band and 40% if they fall above the higher rate threshold. The annual exemption from capital gains tax is £7,500 for the 2001/2002 tax year. The situation is further complicated by the indexation relief which is allowed for gains on disposals after 5 April 1998.
Gains are reduced by taper relief for the number of complete years held after 5 April 1998 and assets acquired before 17 March 1998 qualify for a bonus year of taper relief.#
All very messy, bad for your investment health and quite unnecessary!
BUT... (told you it was coming) the good news is that investments held within a life bond are free of any capital gains tax. There is no liability to capital gains tax and no need to worry about tax when you are deciding to sell or switch. There is also no need to see part of your investment end up in the hands of the Chancellor by way of some complicated mathematical calculation. So it means that within the confines of your greenhouse the Chancellor isn't allowed to get inside there with you. You can garden, prune and rearrange to your heart's content free from his not-so-green fingers!
Inheritance tax

We've already said quite a bit about the damaging affects of inheritance tax. It can seriously reduce the value of a family's wealth with a whacking 40% charge on estates in excess of £242,000 (2001/2002 tax year)#. And with property values continuing to soar, more and more people will find that their home will use up all of this allowance, leaving their orchard in the garden to suffer the entire inheritance tax burden.
By wrapping your life bond into a simple trust, you can ensure that the tax man will receive the absolute minimum from your estate whilst the people you really want the money to go to, get it.
Administration

Imagine if you had several apple trees, but they weren't in one orchard, in fact they were all over the country. Furthermore, perhaps some of your apples were cooking apples, and others were for eating. The situation would be a nightmare (especially if every year the Chancellor wanted a detailed listing of all your trees and each and every apple you'd received) and few people would put up with it. Strange then that many of us put up with exactly that when it comes to our investment portfolio. (Don't worry, I'll be along with another 'good but' in a minute.)
People with diverse investment portfolios will be only too familiar with all the laborious paperwork that is generated, for example, statements of dividends and tax credits, unit statements, income statements and valuations. It may even prove troublesome to establish the exact valuation of the overall portfolio at any one time.

With different parts of the portfolio supplying different information at different times it may be difficult to make an accurate assessment of how the portfolio is performing. Good administration has been made even more important by the fact that self assessment has very firmly shifted the responsibility of paying the correct amount of tax on to the shoulders of the taxpayer. Individuals must now maintain comprehensive records of all their investments and make the appropriate declarations on their self assessment tax return - or face severe penalties from the Inland Revenue.
BUT... (hooray) the good news is that investments held within a life bond are self assessment friendly. What this means is that unless the bond is cashed in or you take out more than 5% of the amount invested in any one tax year then there is no requirement to declare details of the investment or any gains associated with it on a UK Inland Revenue self assessment form. Furthermore, as all your investments can be held within your offshore life bond, all your holdings will be summarised in one place and printed on one comprehensive statement. In other words your greenhouse not only protects you from the tax man but allows you to place all of your trees together in one safe and secure greenhouse.

Objectives:

Probate Avoidance
Avoids the process of establishing the ownership of the (deceased) settlor's estate before the estate may be distributed.

Access
Allows the settlor access to his capital during his lifetime.

How does it work?
Step 1: A cash sum is invested in SLI's offshore investment bond - the Secure Investment Portfolio. This ensures that the investment is exempt from capital gains tax and also provides for a tax effective regular income stream if required.
Step 2: The offshore investment bond is now placed into the Flexible Probate Trust.
Step 3: On the trust application form, the settlor will decide on at least one other trustee (in addition to himself) and name one or more beneficiaries and their % entitlement. (It is essential for there to be at least one other trustee in addition to the settlor otherwise probate would not be avoided. No surviving trustee would exist and therefore probate would be required to establish the new trustees.)
Step 4: During your lifetime, you, as the settlor of the trust, are the primary beneficiary and so have total access to the capital.
Step 5: On your death, the named beneficiaries are able to benefit from the trust. They could also benefit during your lifetime if the trustees (of which you are one) exercise their powers to allow them to do so. The trustees also have the power to enable the discretionary beneficiaries to benefit from the trust.
Regular Payments - The trustees can withdraw up to 5% of the original investment for up to 20 years without any tax liability arising at the time of withdrawal.

Flexible Probate Trust - case study
Jim Jones has £150,000 to invest. He is seeking an income of £7,500. He effects a Secure Investment Portfolio and chooses to take 5% withdrawals. Jim wants to ensure that he has access to the investment as he may require a capital sum in the future. He also wants to ensure that his children gain access to his estate as promptly as possible after his death.
He sets up the bond using the Flexible Probate Trust which means when he dies the executors of his estate gain control of the bond on his death. Jim must also ensure that the other trustees (his children) agree to any withdrawals from the bond.
On Jim's death, control of the bond remains with the surviving trustees, who will have to account fully for the estate, and may have to pay inheritance tax. However they will only be dealing with one jurisdiction, rather than having to obtain probate in the Isle of Man and in the UK.

Objectives:

Probate Avoidance
Avoids the process of establishing the ownership of the (deceased) settlor's estate before the estate may be distributed.

Inheritance tax planning
Enables the settlor to make inheritance tax efficient gifts (i.e. Potentially Exempt Transfer).


How does it work?
Step 1: A cash sum is invested in SLI's offshore investment bond - the Secure Investment Portfolio. This ensures that the investment is exempt from capital gains tax and also provides for a tax effective regular income stream if required.
Step 2: The offshore investment bond is now placed into the Gift Trust.
Step 3: On the trust application form, the settlor will decide on at least one other trustee (in addition to himself) and name the beneficiaries of the trust. (It is essential for there to be at least one other trustee in addition to the settlor otherwise probate would not be avoided. No surviving trustee would exist and therefore probate would be required to establish the new trustees.)
Step 4: You have now made a gift of an asset for the benefit of individuals named in the trust.
Step 5: Now that the gift is made, you may not benefit from the trust in any way if the gift is to be efficient for inheritance tax purposes. The trustees (of which you are one) have the power to appoint benefits or make loans to any of the beneficiaries.
Your spouse will receive any excess over and above that value, again in trust for her benefit. In addition, as your widow(er), your spouse is also a discretionary beneficiary under the nil rate band portion and could benefit from it if necessary.
Regular Payments - The trustees can withdraw up to 5% of the original investment for up to 20 years without any tax liability arising at the time of withdrawal.
 

Gift Trust - case study
Lady Fenella Harriet Smythigton - Smythe - Walpole - Windsor (a widow) has six grandchildren, ranging from age one to age seven. She is aged 70 and has a large estate consisting of a large property and various investments. She is aware of the potential inheritance tax that will be payable on her death and has taken some steps to mitigate it. She also would like to provide a fund so that her grandchildren may benefit for their education.
She has set aside £400,000 for this purpose. She invests the whole amount in the Protected Investment Management Service and appoints the family stockbroker to manage the bond using a combination of unit and investment trusts as well as capital protected funds.
The bond is then placed in the Gift Trust for the benefit of her grandchildren. She appoints herself, her son and daughter and her nephew as trustees. The trustees can immediately decide to make distributions to the grandchildren for their education.
The whole amount placed in trust £400,000, is counted as a potentially exempt transfer from her estate. This means that if she died within the next seven years an amount will be bought into her estate for inheritance tax purposes. Should she die after the seven year period, the whole £400,000 plus any growth will not be counted in her estate.

Objective:
The Secure Estate Plan offers a solution to minimising an IHT liability whilst still maintaining your lifestyle. The Secure Estate Plan will:
• Immediately reduce the value of an estate for IHT purposes
• Ensure that your wealth goes to the people you choose
• Gives you access to a regular, tax-free income stream
• Provide you with the safety net of access to a 'rainy day' capital fund
• Avoid capital gains tax altogether
• Be simple to administer. No self-assessment hassles.

How does it work?
Step 1: A cash sum is invested in SLI's offshore investment bond - the Secure Investment Portfolio (SIP) or PIMS (Protected Investment Management System). This ensures that the investment is exempt from capital gains tax and also provides for a tax effective regular income stream if required.
Step 2: On the bond application form the names of the chosen beneficiaries will be listed as the lives assured on the bond. These will be the people, possibly children and/or grandchildren whom you, the settlor, ultimately wish to benefit from your wealth.
Step 3: You will appoint one other trustee (in addition to yourself) to administer the trust for the benefit of all the beneficiaries.
Step 4: The offshore investment bond is now placed into the Secure Estate Plan. The Secure Estate Plan will create two distinct funds within the bond; the Retained Fund and the Gifted Fund.
You will choose at the outset how much of the plan will make up the Retained Fund and how much will make up the Gifted Fund.
The Retained Fund will remain as part of your estate, providing the reassurance of an emergency or 'rainy day fund' should the need ever arise. At a future date you may decide that you no longer require the 'right' to this fund and could choose to have it included in the gifted fund.
The Gifted Fund is considered to be a gift or a transfer out of your estate for inheritance tax purposes. The value in your estate is immediately discounted, and providing you survive at least seven years, no IHT will be payable on this amount at all.
Step 5: Regular Payments. At the start of the plan you must decide on how much of an income-supplement you wish to receive per annum, based on the original capital investment. Withdrawals of up to 5% per annum over a 20 year period will not be subject to income tax as the Inland Revenue considers such withdrawals as a return on capital. It is important to remember that once the plan has commenced you cannot alter the regular payments.
Step 6: Access to the Retained Fund. As you are named as the person to benefit from this fund then all that is required is to instruct the trustees to make the payment.
Step 7: No longer want the Retained Fund. You are free to change your mind and may at some stage in the future decide that you no longer require access to this rainy day fund. By giving away all rights to it, it would then constitute a gift for IHT purposes and be subject to a new 'seven year period' rule.
 

So how does the Secure Estate Plan help reduce IHT?
When you set up your Secure Estate Plan, you choose what level of regular capital payments you wish to receive and how much capital you wish to have in the rainy day fund. The difference between the total capital invested and the amount of rainy day fund is referred to as the Gifted Fund. The Gifted Fund is treated by the Inland Revenue as a potentially exempt transfer.
The value of the rainy day fund will continue to form a part of your estate for inheritance tax purposes. This is because you are still allowed access to it. If you do decide at some stage that you want to give this away too, it will be treated as a potentially exempt transfer and will eventually fall out of your estate after seven years.

Secure Estate Plan - Case Study
Mr and Mrs Hamilton are both aged 65 and retired. They have three grown up children and two grandchildren. They have paid off their mortgage and have a large capital sum in the building society. They are looking to boost their income but are also mindful that the assets that they have worked hard to accumulate could be subject to inheritance tax, so they are keen to consider methods of reducing their IHT liability.
Their financial position is as follows: 

What if Mr and Mrs Brown die now?

Potential IHT liability would be:

Mr and Mrs Hamilton don't like the idea of the Inland Revenue swallowing up a huge chunk of their estate, so they visit their independent financial adviser who recommends the following course of action:
Step 1: Mr Hamilton uses the money lying in the building society and invests £450,000 in an offshore investment bond. This will provide him and his wife with 'capital secure' investment performance in addition to the benefits of gross roll up. The bond is written on the lives of their children and grandchildren (up to a maximum of six lives).
Step 2: The bond is then placed in the Secure Estate Plan. Mr Hamilton and two of his children are named as trustees.
Step 3: The Secure Estate Plan is set up as follows:
Withdrawals of 5% p.a - tax free - are to be taken from the investment bond for at least 20 years (£22,500 each year with no immediate tax liability); and a 'rainy day' fund of £75,000 is set aside, just in case Mr Hamilton needs it. The Secure Estate Plan will also provide benefits for their children and grandchildren after their death.
The financial position now looks like this: 

* This is the value to the
Hamilton's estate of the plan - the amount invested will still be £450,000.
Value of Secure Estate Plan for IHT 

This represents an IHT SAVING on day 1 of (£134,400 - £66,090) = £68,310!
And, an additional yearly income to supplement their income of (£42,500 - £35,500) = £7,000 per annum.
And, the reassurance of a rainy day fund to the value of £75,000 which they still have access to should the need arise. And also the option to 'give-away' any rights to the £75,000 which would then constitute a gift for IHT purposes.

Objectives:
• Enables inheritance tax planning whilst not making outright gifts
• Ensures that growth on investments accumulates outside of settlor's estate and for benefit of the beneficiaries
• Enables settlor (along with other trustees) legal control over the investment
• Access - allows settlor to retain access to an amount equal to that originally invested
• Flexible - can change the beneficiaries from time to time.

How does it work?
Step 1: Investor establishes an Interest in Possession Trust, with original trustees appointed. Immediate beneficiaries must be named at this stage. The trustees also have power to appoint benefits to a person who falls into the category of potential (or discretionary) beneficiary.
Step 2: Settlor grants an interest-free loan, repayable on demand, to the trustees.
Step 3: Trustees invest the loan amount in a Scottish Life International offshore investment bond. The bond will be written on the lives of the named beneficiaries under the trust, on a multiply lives, last survivor basis. This is to ensure that the bond will continue in force after the death of the settlor.
Step 4: Once the loan has been made. The settlor may appoint himself as trustee, to act jointly with the original trustees. This is done by completing a draft deed of appointment.
Step 5: A trust has now been established whereby the settlor does not have (nor could have) any beneficiary interest. For inheritance tax purposes this means that the settlor has effectively removed the trust fund (after the deduction of any loan owed to the settlor) from his taxable estate.
Step 6: Settlor has full access to the amount of the loan outstanding. The remainder of the trust, incorporating the growth on the investment, is outside of the settlor's estate for inheritance tax purposes and is inaccessible to the settlor.
Flexibility
The flexible provisions of the Exempt Growth Trust allow for a change in beneficiaries under the trust.
Regular Payments - The trustees can withdraw up to 5% of the original investment (i.e. the loan) for up to 20 years without any tax liability arising at the time of withdrawal.
 

Exempt Growth Trust - a case study
Mr and Mrs Spencer have recently retired from the National Health Service as doctors. They have a combined pension of £30,000 which is index linked. They also have a property in the UK and one in France, where they intend spending the majority of the early part of their retirement. They have £200,000 to invest, from which they would like to receive an income of £10,000 per year to supplement their income and help meet the costs of their French property. Along with their other assets there would potentially be a liability for inheritance tax but they are keen on taking steps to mitigate this liability.
They set up an Interest in Possession Trust and appoint themselves and their children as trustees and their grandchildren and future grandchildren as beneficiaries. Mr Spencer grants the trust an interest free loan of £200,000 to the trust.
The trustees invest the amount in the Protected Worldwide With Bonus fund and arrange for withdrawals of 5% each year to be made to Mr Spencer. After 20 years the loan will be paid back and the Spencers can receive no further payments, but the value of the bond will be outside of their estate.
Should they die before they have received the full amount of the loan, the value of the loan outstanding will be taken into their estate for inheritance tax purposes but not the actual value of the bond. For example, if the Spencers die after ten years, then £100,000 would be included in the value of their estate, which could be less than say the bond value which could be £180,000, thus saving £32,000 inheritance tax.

Objectives:

Probate Avoidance
Avoids the process of establishing the ownership of the (deceased) settlor's estate before the estate may be distributed.
Access
Allows the settlor access to his capital during his lifetime.
Inheritance tax planning
Will help mitigate inheritance tax on the death by ensuring that the settlor's nil rate band is used effectively.


How does it work?
Step 1: A cash sum is invested in SLI's offshore investment bond - the Secure Investment Portfolio. This ensures that the investment is exempt from capital gains tax and also provides for a tax effective regular income stream if required.
Step 2: The offshore investment bond is now placed into the Probate Nil Rate Band trust.
Step 3: On the trust application form, the settlor will decide on at least one other trustee (in addition to himself or herself) and name one or more beneficiaries and their % entitlement. (It is essential for there to be at least one other trustee in addition to the settlor otherwise probate would not be avoided. No surviving trustee would exist and therefore probate would be required to establish the new trustees.)
Step 4: During your lifetime, you, as the settlor of the trust, are the primary beneficiary and so have total access to the capital.
Step 5: On your death two separate rights are created; one for the named beneficiaries and the other for the benefit of your spouse. Your beneficiaries will receive an amount, in trust for their benefit, equal to the value of the nil rate band.
Your spouse will receive any excess over and above that value, again in trust for her benefit. In addition, as your widow(er), your spouse is also a discretionary beneficiary under the nil rate band portion and could benefit from it if necessary.
Regular Payments - The trustees can withdraw up to 5% of the original investment for up to 20 years without any tax liability arising at the time of withdrawal.

Probate nil rate band trust - case study

Mr and Mrs Smith are both aged 60 and are approaching retirement. They have two grown up children and one grandchild. They are financially independent and secure. They have paid off their mortgage and have a large cash sum in their bank account. They are seeking to boost their income but are also mindful that the assets that they have worked hard to accumulate could be subject to inheritance tax, so they are keen to maximise the tax efficiency of their investments whilst retaining access to their capital. Their financial position is as follows:

 
Potentially IHT liability if Mr Smith and then Mrs Smith died, not having made full use of their exemptions.
 

Mr and Mrs Smith visit their independent financial adviser, who recommends the following course of action:
Step 1: That Mr Smith effects an offshore investment bond for £300,000, which will provide them with capital secure investment performance as well as offering the benefits gross roll up. The bond is written on the lives of their children and grandchild up to a maximum of six lives.
Step 2: The bond is placed in the Probate Nil Rate Band trust. Mr Smith and two of his children are named as trustees.
Step 3: The Probate Nil Rate Band trust is set up as follows withdrawals of 5% each year are to be taken from the investment bond (£15,000 each year with no immediate tax liability); and should the Smiths need access to the bond they can, with the agreement of all the trustees, make a withdrawal from the bond. The Probate Nil Rate trust will also provide potential benefits for Mrs Smith, the children and grandchildren after Mr Smith's death.
Their revised tax position is as follows:
 

New potential IHT
New potential IHT liability if Mr Smith died now:

IHT liability on Mrs Smith's death

Important Note
For many people, the first thing that springs to mind when trusts are mentioned, is saving or avoiding tax. Trusts have certainly been used for this purpose, for many years, and as a result a large body of anti-avoidance legislation has built up in order to counter perceived 'abuses' of the tax rules.
Tax planning is often described as a cat-and-mouse game, with the tax and trust planner trying to stay one step ahead of the Inland Revenue. For this reason, anti-avoidance legislation in the UK has developed over a long period on a piecemeal basis. Many countries have in recent years adopted a broad brush approach, by introducing general anti-avoidance legislation, the purpose of which is to allow the tax authorities to 'look through' arrangements entered into for tax avoidance purposes. The UK Inland Revenue has, up to now, not succeeded in introducing any such general anti-avoidance rules. The anti-avoidance measures adopted in the UK generally target the following types of arrangement:
"Sham" arrangements, where things are not as they first appear. In particular, trusts where the settlor could be said to have not truly given away the trust assets are considered 'offensive'. Such trusts include those where the settlor, and often those where the settlor's spouse or close family members, can benefit. These settlor-interested trusts are usually regarded as tax neutral, with the settlor being treated as the taxable person instead of the trustees or beneficiaries.
"Composite" arrangements, where the tax saving is achieved only as a result of an often-complex series of separate transactions. Again, such arrangements are put under the microscope, and any transactions that are to be purely for tax avoidance purposes, with no genuine commercial purpose, are disregarded.

Ross Pays is the Chairman of The FAA based in Cyprus. FAA offer advice on wills, tax registration services, home, health and car insurance and tax planning, including Inheritance Tax Planning, together with full accounting services.

Visit Ross Pays website at www.rosspays.com, Telephone 00 357 25 82 58 76, Fax 00 357 25 33 35 93 or e-mail ross@rosspays.com
Initial consultations are free and no obligation and fee quotations will be provided in advance for all services.