Estate planning often gets pigeonholed as being all about minimising tax liabilities on inheritance. But in truth, there’s much more to it than that.
Sure, a lot of people would rather see as much of the wealth they leave behind go to their children, family or chosen beneficiaries rather than to the tax man. But people are equally concerned about the wealth they leave behind being used in the right way.
For example, if you want to leave part of your estate to young family members, you might be concerned about ensuring their portion is safe until they reach an age when they can manage it for themselves. Or you might want money you pass on to be used in a specific way, to send a child or grandchild to university or to buy them a home, for example.
These are just some examples of where passing on wealth in the form of a trust might be attractive. A trust is a legal mechanism which allows the owner of assets (the “settlor”) to ring-fence them for a specific purpose, e.g. to be passed on to named beneficiaries within a specified timeframe, or to be used for specific purposes. On setting up a trust, legal control of the assets passes from the settlor to a trustee, who is responsible for ensuring the conditions of the trust are met.
In estate planning, trusts offer a number of benefits, though not necessarily the most obvious ones people associate with inheritance strategies. Let’s look more closely at the pros and cons.
Pros
As touched upon, a key benefit of using a trust for estate planning purposes is the ability to control the distribution of assets. There is a considerable amount of flexibility in how this can be achieved, resulting from the different trust options available.
For example, a Fixed Trust allows the settlor to specify who the beneficiaries of the assets put into trust are, what each will receive and when. This even extends to stating that an asset can be possessed by one person up until their death, before passing to another. This is commonly used to pass on property, providing for, say, a sibling or parent before possession goes to children or grandchildren.
Similarly, Fixed Trusts can be used to overcome some of the complexities of inheritance law as it relates to marriage. For example, if you and your partner both have children from other relationships before you marry, when you pass away, whatever your spouse inherits from you is theirs to do with as they please, which might include leaving it to their children but not yours. A trust can be used to specify exactly who you want to inherit your assets.
Alternatively, Discretionary Trusts leave it up to the trustee to decide how assets are disposed of, within a set of legally binding parameters. This is commonly used in cases where trusts generate additional income and/or capital through investment, and that wealth is set aside for children to come into possession of at a later date.
How much each beneficiary ends up getting can’t be fixed when the trust is set up, so it is left to the trustee to decide. Equally, they have the discretion to decide whether disposals take the form of a lump-sum inheritance or beneficiaries taking an income from the trust, depending on what suits their circumstances best.
Cons
Despite what is commonly assumed, trusts do not necessarily help to make inheritance more tax efficient in Irish law – and even when they do, the processes are often very complicated for relatively little advantage.
Unlike other countries, trusts set up to bequeath wealth to named individuals are not exempt from tax. With Fixed Trusts, for example, beneficiaries become liable for Capital Acquisitions Tax (CAT) at the moment they take possession of the assets, subject to the normal thresholds and rates.
Furthermore, settlors may find themselves liable for Capital Gains Tax when they put assets into a trust, as it counts as a disposal of assets. This does not apply if a trust is set up after the death of the settlor as per instructions in their will.
Finally, Discretionary Trusts are subject to a specific Discretionary Trusts Tax (DTT), which is charged at 6% of the total value of assets when the trust is set up, and 1% per annum thereafter. This is to offset the fact that Discretionary Trusts give trustees the power to dispose of assets in the most tax-efficient way.
Whether your goal is tax efficiency or protecting the way your wealth is passed on in the future, trusts do form an important role in estate planning. But it takes careful consideration to get the benefits you are looking for.
Speak to an expert
Trusts represent a particularly complex area of financial law, so it is strongly advised you take professional advice to talk through the options. If it is something you are considering, contact our Estate Planning & Inheritance Tax team to find out more.
