Investing trust money – are you getting it right?

Many people will at some point be involved with creating or administering a trust. Some people are trustees and don’t even realise it. For example, if you were the executor of your mother’s or father’s estate, and they left money to all of their grandchildren who survive them and reach age 25, you are in fact the trustee of a trust. Our technical expert Ian Dyall explains more about what a trust is and what trustees need to consider when investing.

Trusts – a definition

Trusts are used often in financial planning, particularly when planning to reduce Inheritance Tax, save money for children or provide for the vulnerable. A trust is created when a person (the settlor) places money or assets in the hands of trustees to hold for the benefit of the beneficiaries. The trustees are legally bound to administer the assets in the trust in line with its terms and conditions.

Some people worry that trusts will be complex or expensive to run, but the cost and complexity of a trust depends heavily on how you invest the money within it.

Trustees are legally bound to administer the trust assets in line with its terms and conditions.

Investing trust assets

Trustees have a legal obligation to invest the trust funds wisely. When doing so there are three key areas they need to consider:

  • Their legal obligations as trustees
  • The terms and conditions of the trust
  • The basic principles of sensible investing

Legal obligations

The Trustee Act 2000 places a “duty of care” on the trustees to act with “such care and skill as is reasonable in the circumstances” when managing the trust on behalf of the beneficiaries. If they don’t, the trustees could be sued by the beneficiaries.

The Act states that trustees have a legal responsibility to review the investments from time to time, and when doing so they must “obtain and consider proper advice” from “a person who is reasonably believed by the trustee to be qualified to give it.” In Scotland, similar obligations are outlined in the Charities and Trustee Investment (Scotland) Act 2005.

Terms of the trust

Trust deeds (or terms of the Will) generally allow trustees to invest in almost any asset. However, not all assets would be suitable when looking at the terms and conditions of the trust.

For example, some trusts require the trustees to maintain a fair balance between the income produced and the capital gains made by the investments. These trusts are often found in a Will. They will usually give an entitlement to any income produced to one beneficiary, before paying the capital to other beneficiaries upon their death. In this case it would not be suitable to invest in an asset which does not produce income, such as an investment bond, or an investment that accumulates the income, for example “accumulation” unit trusts.

Basic principles of investing

The basic principles of investing that apply to trusts are similar to those that apply to individuals. For example, in both cases sufficient money should be held in cash to cover any annual expenses and the short-term needs of the beneficiaries.

The assets should also be diversified, so that economic conditions that lead to losses on one investment are balanced by potential gains on other investments. The likely volatility of the overall portfolio should be suitable to the level of risk that the trustees feel is appropriate for the beneficiaries.

Assets held in trust may still be liable to Income Tax, Capital Gains Tax and Inheritance Tax. The level of tax due depends on the terms and conditions of the trust, but many trusts are liable to tax at the highest rates – 45% Income Tax and 20% Capital Gains Tax (28% on property). Trustees must declare the income and gains made to HMRC annually, and pay any tax that is due from the funds within the trust.

This is off-putting to some trustees as paying tax at the highest rate feels inefficient, and reporting sounds like a lot of effort. However, taking advice on the best way to hold assets can dramatically reduce both the tax payable and the level of reporting involved.

For example, holding a discretionary investment portfolio directly will mean that every year the trustees must declare the Income Tax due on any dividends and the Capital Gains Tax due on any gains made. They must also pay the tax due, possibly at the highest rates. On the other hand, holding the same portfolio in an offshore bond wrapper defers any Income Tax and removes the need to report. If distributions are to be made to the beneficiaries, then instead of encashing within the trust (potentially incurring tax at 45%), portions of the bond can be assigned to beneficiaries who may be liable to tax at a lower rate.

Trusts can be simplified with expert advice

While trusts can potentially be complex and expensive to run, with good advice and the careful selection of investments the administration can be greatly simplified and the tax burden reduced to similar levels as those that the beneficiaries would pay on a personal investment.

Speak to a financial planner

Through our wider Tilney Group we have a nationwide team of expert financial planners. They can give you advice on investing in trusts and managing a tax bill. To find out how they could help you, simply book a no-obligation initial consultation on our Tilney website. You can also book a consultation by calling us on 020 7189 2400 or emailing best@bestinvest.co.uk.

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Tax