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Pilot Trusts

PLEASE SEE OUR UPDATE DATED 15 DECEMBER 2014

RELEVANT TO

People interested in Inheritance Tax planning, providing for grandchildren or disabled beneficiaries

SUMMARY

Pilot Trusts can often be used for people who wish to undertake Inheritance Tax (IHT) planning. They are lifetime trusts set up with a nominal amount and which are ready to receive further funds and/or property at a later date or upon the death of the donor by way of a legacy in their Will. Until such time that the trust receives further funds, it can lie dormant.

WHAT IS A PILOT TRUST?

Pilot trusts are normally drafted as discretionary trusts and are created with an initial trust fund of as little as £10. The Trustees could be the client and their spouse or whomever the client believes to be suitable for the role. Settling a nominal sum ensures that the trust has legal presence at the date of the trust deed but it is not until it receives more assets that it becomes an active trust. Transfers of nominal sums into trust often fall within the Settlor’s annual exemption. There will be no IHT charge on the creation of the pilot trust and the £10 transferred into it will not form part of the Settlor’s cumulative total of chargeable transfers. Pilot trusts can have assets added to it immediately or after a period of time and can be used for numerous purposes, for example:

• A property could be transferred into a trust and registered in the Trustees’ names

• A pilot trust could be formed to receive pension death benefits

• Pilot trusts can be used in conjunction with a Will where the trust is set up during the Settlor’s lifetime with nominal funds but further funds may be added only after the Settlor’s death via a specific legacy in the Will

• A series of pilot trusts could be created to take advantage of several nil rate bands which then enhances the IHT planning effect.

PILOT TRUSTS AND INHERITANCE TAX PLANNING

Pilot trusts are primarily used for tax planning purposes, and the principal advantage is that each pilot trust is entitled to its own nil rate band. For this to take effect, the Settlor must have his full nil rate band available to him, in other words there must not have been any chargeable transfers made over the seven year period before setting up the trust. Currently each individual has a maximum nil rate band amount of £325,000 available to them (increasing to £329,000 as from 6th April 2013). Setting up a series of pilot trusts on consecutive days and transferring the funds into the trusts on the same day could enable you to minimise future IHT exposure on the trust assets in particular in relation to the on ten-year anniversaries (“periodic charges”) and when assets leave the trust (“the exit charges”).

For example, you wish to put £300,000 in a discretionary trust for your three grandchildren. In the past seven years you have not made any chargeable transfers and therefore you have the full nil rate band available. A single trust of this amount would not exceed the £325,000 nil rate band, and the excess (once over the nil rate band level within the trust) would be liable to IHT on ten year anniversaries (at the rate of 6%) and on “exit charges” (i.e. distribution of capital).

However to be more tax efficient, you could consider creating three separate trusts of £100,000. Each will still be within the nil rate band. The best solution therefore is to create three pilot trusts; these are usually made on separate days (due to the fact that we do not wish them to be “related” settlements) with nominal sums (£10). Subsequently, at a later date you can add £100,000 to each pilot trust. For IHT purposes each trust would have its charges calculated by reference to its own nil rate band, thereby allowing the assets to grow and in effect having 3 nil rate bands to utilise with the trusts themselves.

PILOT TRUSTS AND WILL PLANNING

Just as you can add to a pilot trust in your lifetime, you can also do so on death through your Will. A word of caution, however. Each transfer to a discretionary trust is a lifetime chargeable transfer for IHT purposes. So, it is best to make the transfers to the pilot trusts on the same day and then none for another 7 years.

PILOT TRUSTS IN PRACTICE

Pilot trusts are useful as they enable you to benefit different members of the family, future generations and/or children from previous marriage. The trusts may also offer security to your assets from creditors, divorce claims, future care costs etc. They can also be use as efficient tax planning vehicles for lump sums which are payable either under a pension scheme or under a company’s death in service shceme.

Pilot trusts can be set up easily and quickly, and can be formed at the same time as having your Will prepared. Until the trust starts receiving income or making chargeable gains there is no need to register with HMRC and there is no need for trust accounts. As a result, there are unlikely to be on-going administrative costs until property is transferred to the trust. The pilot trust documents can be stored together with your Will until such a time that it is required.

If you would like further information, please contact Richard Monkcom, Roy Campbell or Helen Freely of Druces’ Private Client team.

This note does not constitute legal advice but is intended as general guidance only. It is based on the law in force in December 2012.

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