Twist of Fate: Safeguarding Bereaved Minors Through Succession Planning
We first meet Oliver at a workhouse, an orphan after the death of his mother during childbirth. Following his escape from the clutch of Mr Bumble, Oliver embarks on a journey to London where he meets the Artful Dodger. Oliver says that he has “come to London to make [his] fortune”, which inspires Dodger to introduce him to Fagin, who trains children to pickpocket. Unwittingly Oliver is drawn into a world of crime, where he encounters other crooks such as Bill Sikes.
“Trusts Glorious Trusts”
There are several characters that look to exploit Oliver, making him vulnerable. If we were to presume that Oliver’s mother wished for him to inherit from her estate, she has some options to choose from to ensure he is provided for and protected in the future.
Bereaved Minor’s Trust
A Bereaved Minor’s Trust (BMT) is a mechanism, under the law in England and Wales, designed to protect the inheritance of children under the age of 18 whose parent has died. The trust can arise from the Will of the parent, or alternatively where there is no Will, following the rules of intestacy.
The following conditions must be satisfied in order to qualify:-
- At least one of the minor’s parents must have died;
- The trust must be created by the parent’s Will, on intestacy, or under the Criminal Injuries Compensation Scheme; and
- The trust must meet the conditions in Inheritance Tax Act 1984, section 71A:-
- The minor becomes absolutely entitled to the trust property no later than their 18th birthday;
- Whilst the minor is under 18, if any capital is applied, it is applied for the benefit of the bereaved minor; and
- While the beneficiary is under 18, they are entitled to all the income generated by the trust, or if any income is applied, it is applied for the benefit of the bereaved minor.
The assets within the trust are managed by trustees until the child turns 18. Prior to this, trustees can choose to use the income and capital for the child’s maintenance, education, or benefit. Once 18, the child becomes absolutely entitled to the trust property and any accumulated income.
However, what if Oliver’s mother has concerns that 18 is too young for Oliver to acquire all this money?
18-25 Trust
An alternative would be an 18-25 trust, which has the benefit of extending the age entitlement of receiving the inheritance allowing for a gradual transition to financial independence. In addition, this greater control prevents the potential exploitation of an 18-year-old Oliver and his inheritance from the likes of Fagin.
Similar conditions to BMTs must be satisfied in order to qualify:-
- At least one of the beneficiary’s parents must have died;
- The trust was created by the parent’s will, on intestacy, or under the Criminal Injuries Compensation Scheme; and
- The trust must meet the conditions in Inheritance Tax Act 1984, section 71D:-
- The beneficiary becomes absolutely entitled to the trust property no later than their 25th birthday;
- While the beneficiary is under 25, if any capital is applied, it is applied for the benefit of the bereaved young person; and
- While the beneficiary is under 25, they are entitled to all the income generated by the trust, or if any income is applied, it is applied for the benefit of the bereaved young person.
“You’ve Got to Pick a Trust (or Two)”
So now Oliver’s mother has a better understanding of the two trusts available to include in her Will. But how does she pick between them, apart from the consideration of the age-entitlement? The answer – tax!
Capital Gains Tax
Any disposals or acquisitions within a trust will be subject to capital gains tax. However, trusts do benefit from an annual trust allowance of £3,000 (for the tax year 2023-24). Above this, gains on residential property are taxed at 28%, and 20% for other assets.
Capital gains tax holdover relief is available when the beneficiary becomes entitled at 18 and the trust comes to an end. Effectively deferring any gain until the beneficiary later disposes of the assets.
Income Tax
The current rate of income tax for trusts is 45% (2023-24) on gross non-dividend income that exceeds £1,000. The rate for dividend income is 38.1%. If the gross income does not exceed £1,000 then the standard rates of tax will apply (20% and 8.75% respectively).
Whilst this applies to both types of trust, BMTs have an additional tax-saving option. The trustees of a BMT can make a ‘Vulnerable Persons Election’, which results in the trustees paying at the beneficiary’s rate of tax, as opposed to the trust’s higher rate.
Inheritance Tax
BMTs are tax efficient as they are exempt from the inheritance tax liability provided the minor inherits the assets at 18. Furthermore, there will be no exit charge or 10-year anniversary charges during the trust period.
The inheritance tax implications for an 18-25 trust differs from that of a BMT. Once the beneficiary is over the age of 18, the assets in the trust will be subject to an exit charge (up to a maximum of 4.2% if the child inherits at 25 years old) if the trust fund exceeds the nil rate band (NRB) allowance (£325,000). In saying that, the inheritance tax exit rates are considerably low, or zero, if the trust fund is £325,000 or less.
In undertaking her estate planning, Oliver’s mother may have been confident that a BMT would provide for Oliver whilst allowing him to benefit from the favourable tax treatment. However, the additional financial control 18-25 trusts offer may be appealing.
“Reviewing the (Trust) Situation”
Amidst the chaos Oliver finds serenity with Mr Brownlow, who wrongly accused Oliver of pickpocketing in the streets of London. Despite the initial misunderstanding, Mr Brownlow takes Oliver into his home and provides him with protection, education, and love. It later transpires that he is his grandfather. If we were to assume that Mr Brownlow wanted to extend this by providing for Oliver in his Will – what would his options be?
Relevant Property Trust
Where a trust is created from a grandparent to a bereaved grandchild, it cannot qualify as a BMT or a 18–25 trust. However, if they still wanted the trust to be contingent upon the child reaching a particular age, the trust would be classed as a Relevant Property Trust (RPT).
Tax Implications
As with the other trusts, when a distribution is made to a beneficiary, this will be a chargeable event for capital gains tax purposes. Holdover relief can be claimed so that the gain becomes payable when the beneficiary themselves sell the asset.
The income position is also the same, save for the ‘Vulnerable Persons Election’, which is only available to BMTs.
The main difference of RPT is the fact they are subject to their own inheritance tax regime. RPTs incur a periodic 10-year anniversary charge, starting from the creation of the trust (up to a maximum of 6%). There will also be an exit charge when the funds are paid out. Exit charges only apply to trust capital and do not apply where income is distributed to a beneficiary, however this may give rise to income tax charges. There will be no charge if the trust capital is below the NRB (£325,000).
“It’s a Trust Fund Life”
If Oliver’s mother and Mr Brownlow undertake effective succession planning, by consulting a solicitor to ensure the trusts are set up correctly and comply with all legal requirements, Oliver can “consider himself” better equipped to make his fortune in London through legitimate means, free from Dodger, Fagin and Bill Sikes.
”Orphan” Trusts
When a person dies whilst they are in employment any benefits from the pension or life assurance will be paid to their family or nominated beneficiaries. Where the funds are left to a minor beneficiary, such as their minor child, the funds are paid from the pension trustees to be held on a trust until the age the beneficiary becomes entitled to the funds. These trusts are known as Death Benefit Trusts or “Orphan” Trusts (although the minor child may still have one parent surviving so the term is a bit misleading).
The pensions trustees have two years to pay out any death in service payment otherwise they must pay a 45% tax charge. As a minor beneficiary is unable to give a valid receipt of funds, these funds must be paid to a trust.
The surviving parent/guardian can request funds from the trust to meet the child’s expenses; educational expenses are looked on favourably and the trustees look to ensure the beneficiary is not missing out on opportunities as a result of them losing a parent.
Where the funds are below £20,000, a bare trust is the likely choice of trust to be created. A bare trust is held on behalf of the minor beneficiary but for tax purposes, the income and gains are treated as that of the beneficiary personally. The beneficiary becomes absolutely entitled to the funds at 18.
When the trust is professionally managed, trust accounts are prepared, together with a statement of income and gains for the beneficiary and this is typically forwarded to their guardian each year.
Where the funds are over £20,000, a life interest trust would typically be recommended. This enables the trustees to chose the date of entitlement, usually when the minor child reaches 21, 23 or 25 years old. This provides protection over the capital of the trust should the beneficiary be easily led or not mature enough to manage a larger sum. The beneficiary is entitled to the income in the trust as it arises but it can accumulate in the trust to meet expenses as and when required.
In addition to trust accounts, a tax return is required for a life interest trust and income is taxed at the basic rate of tax. An R185 is then issued to the guardian to enable them to reclaim the tax paid by the trustees, if appropriate.
All trusts are now required to be registered using the HMRC online trust register. Bare trusts will be registered as a non-taxable trust and life interest trusts registered as taxable trusts.
Trustees are also required to complete annual due diligence on the beneficiaries to determine their tax residence for Common Reporting Standards (CRS) and Foreign Account Tax Compliance Act (FATCA) purposes.
