Planning matters. Special edition. Preserving wealth through the generations Jane's case study. Part 4 of 5

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1 WARNING: The information in these articles was correct at the date of issue and may have changed. oracle technical For adviser use only not approved for use with clients Special edition Part 4 of 5 Planning matters Preserving wealth through the generations Jane's case study Jane's case study, covering: > Divorce > Mechanics of sharing assets > Trustee responsibilities

2 Oracle Technical special edition contents Jane an overview 4 Income tax calculation for Jane (current) 5 Order of tax rules, dividends and savings income 6 Divorce 9 Jane and Jack's divorce what has been decided 10 Mechanics of sharing the assets 12 Jane's tax calculation post pension contribution 15 Trustee duties and responsibilities background 16 Duties to be performed on appointment 16 Investment duties 17 Protecting the interests of beneficiaries 17 Keeping accounts and records 17 The solution Contact us Speak to a technical expert If you would like more information on any of the topics covered in this edition of Oracle, you can speak to one of our experts. Our Technical Helpline team can help you with generic technical product queries, tax issues relating to life and pension products, trusts, and pensions legislation. Our Technical Helpline is also backed up by a team of specialists who are on hand to work with you on any particularly complex cases or client planning strategies. > technical.helpline@prudential.co.uk > > Opening hours Mon Fri 10:00 16:00 Request an illustration Adviser Service Centre > Freephone > Fax > Prudential LANCING BN15 8GB > contact.us@prudential.co.uk > Opening hours Mon Fri 08:30 18:00 Alternatively you can visit our website at for an illustration. Your call may be recorded or monitored in order to improve our service. The following is based on our understanding of current taxation, legislation and HM Revenue & Customs (HMRC) practice, all of which are liable to change without notice. The impact of taxation (and any tax reliefs) depends on individual circumstances. 2 For adviser use only not approved for use with clients

3 For adviser use only not approved for use with clients Jane Jane is a 43 year old who works for an IT company, she has a successful career and three children (ages 5, 3 and 1). Unfortunately, she and her husband have decided that their relationship is at an end and they are seeking to divorce after sixteen years of marriage. Her husband, Jack (46), is a customer service adviser in a bank. Jane and Jack live in Manchester. She has a good salary but Jane and Jack have a lot of expenditure as they pay for childcare for 4 days a week (Jane s mum Margaret looks after the children the other day). Jane needs to work out the financial implications of her divorce including the impact on her and her husband s pensions. Her mum, Margaret, has also asked her to be a trustee of a trust she s thinking about setting up and Jane needs to know what is involved. Jane and Jack's assets and liabilities at date of separation > House 225, ,000 mortgage outstanding > Defined contribution occupational pension scheme (Jane) 42,000 (6% employer and 6% employee contributions) > Shares (Jane) 24,000 (base 11,000). Yield 3.5% > Cash ISA (Jack) 5,000 > Onshore bond (joint) 11,000 > Pension (Jack) Cash Equivalent Transfer Value 270,000 Jane and Jack s current income and expenditure Income > Salary (Jane) 58,000 > Salary (Jack) 36,000 > Share dividends 840 > Child benefit 2, ClientFinder Jane is a good example of a Modest Mortgages client type. Visit our ClientFinder tool to find out more about this client type and if there's a concentration of them in an area near you. Solution Throughout the case study we investigate: > Divorce > Mechanics of sharing assets > Trustee responsibilities Expenditure > Childcare 16,000 > Mortgage 7,200 > General household expenditure 24,000 For adviser use only not approved for use with clients 3

4 Oracle Technical special edition Jack has recently moved out and it is important to look at the advice requirements on an individual basis for Jane who is the client. Income tax calculation for Jane (current)* Income Savings income Dividends Total Income Salary 58,000 58,000 Child benefit 2,501 2,501 Dividend income Dividends Total 60, ,341 Personal allowance** (11,500) (11,500) Pension contribution paid gross (3,480) (3,480) Child benefit tax free (2,501) (2,501) Taxable 43, ,860 33,500 taxable 20% 6,700 6,700 9,520 taxable 40% 3,808 3, % 0 0 Child Benefit tax charge 1,325 1,325 Income Tax Payable 11, ,833 * As Jane resides in Manchester she will be subject to the UK taxation in respect of all of her taxable income. If she was resident in Scotland she would be subject to the Scottish Rate of Income Tax (SRIT). SRIT has set a lower threshold for the payment of higher rate tax, 43,000 instead of 45,000 which has been set for the rest of the UK in (before deduction of any Personal Allowance). For further details see our further support section at the end of this article. ** Standard Personal Allowance ( ) subject to reduction for income in excess of 100,000. ***See overleaf for Child Benefit tax charge calculation. 4 For adviser use only not approved for use with clients

5 For adviser use only not approved for use with clients Child benefit calculation Adjusted net income (for allowance/benefit purposes) 55,360 Income in excess of limit 5,360 Excess in multiples of Number of children 3 Child benefit 2,501 Child benefit tax charge 1,325 Net child benefit 1,176 Order of tax rules, dividends and savings income Broadly, the first slice of a person's income comprises earnings, pensions, taxable social security payments trading profits and income from property. The next slice is savings income, then dividend income with Chargeable Event Gains and Capital Gains Tax thereafter (the latter two are not relevant in Jane s case). Income tax calculation implications for Jane Jane s income is sufficient to fully absorb her personal allowance of 11,500 in 2017/18. Her taxable income uses up the 33,500 of the basic rate band and 9,520 of the higher rate band meaning that she will be taxed at both 20% and 40% respectively. As a working parent with a great deal of expenditure, Jane doesn t have any savings income. For more information on how savings income is taxed please see the further support section later. After non-savings income (and given her lack of savings income), Jane s dividend income is then considered. In view of the 5,000 dividend allowance, she will pay no tax on the first 5,000 of dividend income. As Jane only has 840 of dividend income then she won t pay any additional tax. The rates of income tax on dividends received above the allowance are > 7.5% for dividends taxed in the basic rate band > 32.5% for dividends taxed in the higher rate band > 38.1% for dividends taxed in the additional rate band Therefore, if Jane were to receive dividends which exceeded the 5,000 the excess above the dividend nil rate would be taxed at 32.5% (subject to it not exceeding the additional rate band). Tax rate Income band (adjusted net income) Basic 20% Up to 45,000 Higher 40% 45, ,000 Additional 45% Over 150,000 For adviser use only not approved for use with clients 5

6 Oracle Technical special edition Tax relief on pension contribution net pay Jane is a member of her company s occupational scheme. This means that her member contributions are paid over to the administrator by the sponsoring employer. This is an example of a net pay contribution. Under net pay, Jane s contribution is deducted, by her employer, from her salary before her tax is calculated. This means that Jane receives tax relief immediately and directly through her salary. Her taxable income is reduced by 3,480. High income child benefit tax charge Child Benefit remains a universal benefit so Jane receives 2,501 per year for her three children. However, if someone: > has adjusted net income of more than 50,000, and > lives with a partner, in a household where Child Benefit is claimed or claims themselves, and > is the partner with the highest adjusted net income. then they will incur a tax charge which removes or partially removes the benefit of receiving Child Benefit. The definition of partner includes those married, in civil partnerships or couples living together as if married or civil partners. Adjusted net income is the measure currently used to work out entitlement to personal allowances. Adjusted net income is, broadly, taxable income (it should be noted that this includes all rental income, dividends, FULL amount of bond gains and any other taxable income). Certain deductions are allowed, such as the gross value of personal pension contributions, gift aid and trading losses. For those with child benefit and adjusted net income between 50,000 and 60,000 then the charge will be 1% of the total child benefit for every 100 of income over 50,000. The charge applies to the partner with the highest adjusted net income regardless of who actually receives Child Benefit. As Jane has adjusted net income of 55,360 she is liable to a tax charge of 1,325. The amount of the charge will be collected through self- assessment or PAYE. The recipient of Child Benefit may decide not to receive benefit payments which would mean that they or their partner will not be liable to the tax charge. However, claims should be completed for new children born so that entitlement to National Insurance credits is not lost. However, even with the tax charge, it is still more beneficial for Jane to receive the child benefit. Jane could ask for the child benefit to be paid to Jack as he is a lower earner and no longer living in the family home. However, if Jack were to receive Child Benefit for the children and they are living with Jane and Jack contributes at least an equal amount towards the children s upkeep then the charge will still apply to Jane. Divorce Splitting the assets Jane and Jack will need a solicitor to deal with the divorce due to the complexity of the financial arrangements and the fact that they have children under 16. However, financial advice at this time is also crucial. Often couples know the value of assets such as investments and houses but they don t know the value of their pensions and these could be the largest asset to be dealt with on divorce. Jane and Jack will need to sit down with their solicitors, not only to discuss how their children s welfare will be dealt with but also to consider how their assets should be split on their divorce. As Jane and Jack live in Manchester, the law of England and Wales applies and all reference in this case study is to the law of England and Wales. For more information on how the law in Scotland works please see the tech centre article on divorce mentioned in Further support at the end of this article. 6 For adviser use only not approved for use with clients

7 For adviser use only not approved for use with clients Asset House Jane s pension scheme Jack s pension scheme Value for the purpose of divorce 105,000 equity 42,000 fund value 270,000 Cash Equivalent Transfer Value Jane s shares 24,000 Jack s cash ISA 5,000 Onshore bond 11,000 Total 457,000 There are 3 ways in which pensions can be dealt with on divorce; offsetting, earmarking (attachment) order or pension sharing order. Jane s solicitor explains the three options as; Offsetting This involves getting the value (usually the cash equivalent or transfer value) of the pension benefits as at the date of the divorce. This value would then be included in the total value of the matrimonial estate to be divided on divorce. The value of the pension is offset against other assets. Pre April 2015 pensions were not usually valued on a pound for pound basis with other assets, due to the lack of access to the full value. In practice the value apportioned could be anything between 25% and 80% of the fund value and it could depend on how close retirement was. This was discussed in the case of Maskell v Maskell [2001]. The County Court Judge had suggested that the pension could be compared on a like for like basis. On appeal, Lord Justice Hope stated that the judge had made the elementary mistake of confusing present capital with a right to financial benefits on retirement, only 25 per cent of which maximum could be taken in capital terms, the other 75 per cent being taken as an annuity stream. However, for those silver divorcees who are over 55, there is now total access to defined contribution pension funds. This may lead to value parity with other assets. If so, the tax and future contribution issues surrounding accessing flexibility may need to be addressed in the settlement. Once the value has been decided then the ex-spouse receives another asset, or share of another asset instead of a share of the pension. For example, this might mean the ex-spouse receiving a larger share of the matrimonial home to compensate for the pension share. Offsetting is common especially for those clients with many assets. Also, clients who value their pensions may be willing to give up access to more liquid assets to retain control of their pension. For Jane and Jack, offsetting might not be the obvious choice. Although Jack is the lower earner, his final salary scheme makes up more than 59% of the total assets. If it was decided that a 50% split was needed then not only would Jack have no disposable assets and no way of buying another property due to the lack of a deposit, but he would also need to find some money to give to Jane. For adviser use only not approved for use with clients 7

8 Oracle Technical special edition Attachment order An attachment order (also commonly referred to as earmarking) is effectively deferred maintenance. This is not as common as it was before the introduction of pension sharing due to the disadvantages. The court instructs the member to get a valuation of the pension benefits. The court will use the CETV basis, and all pension benefits, including those earned before marriage, are taken into account (except any already earmarked from an earlier divorce). The benefits that can be earmarked in England and Wales and Northern Ireland are; > a specified percentage of the pension benefits when the member starts to draw their benefits. > a share of the lump sum available when benefits are accessed > a specified percentage of any lump sum death benefit in the event of the death of the member before retirement. There are disadvantages to attachment orders. The main one is that there is no clean break. In addition, the order lapses on the; > remarriage of the ex-spouse in relation to pension payments > death of the member (unless the Court Order specifies otherwise) The ex-spouse has no control over when benefits are taken and what investments the fund is in. The pension is taxed as the member's income and attached payments are paid after tax. If the member is a higher rate taxpayer and the ex-spouse is a non or basic rate taxpayer then this could mean less cash for the exspouse. In addition, the method of valuation for divorces could have serious consequences for those who marry late in their working life or for those who have been divorced more than once. Pension flexibility may have a significant impact on the application of attachment orders potentially leaving scope to circumvent the requirements set out in the order, unless the details in the order are very specific. However, very specific orders can also mean that providers can t allow the member to go into drawdown. For these reasons, an attachment order would not be a sensible option for Jane and Jack. Pension Sharing The aim of pension sharing is to separate the ex-spouse's pension entitlement from the member's pension so that there is a clean break, in contrast to earmarking. Pension sharing is available to couples divorcing throughout the UK, but isn t compulsory. However, in both England and Wales, this can only be achieved by a court order which means there is an added cost implication. The Court instructs the member to get a CETV along with certain other information about benefits. If a CETV has been provided within the last 12 months, that figure can be used. The Court will decide how much of the pension rights should be allocated to the ex-spouse and the member s pension rights will be reduced by a corresponding amount. This reduction is known as a Pension Debit. Again in England and Wales this must be a percentage of the total value. This is then allocated to the ex-spouse and becomes a 'Pension Credit' if paid from uncrystallised funds and a 'disqualifying pension credit'. The existing pension scheme can choose to allow the exspouse to join the scheme in her own right, OR to take the transfer value to another registered pension scheme. This would seem the sensible option for Jane and Jack. It means that there is a clean break in pension terms. It would also allow Jack to still have access to some assets which could be sold. Other assets Jane owns some shares and Jack owns a cash ISA. The first question to discuss with the solicitor in relation to these assets is if the assets are actually a matrimonial asset. It is possible that they could be pre-acquired assets. There is no statutory definition of what a pre-acquired asset is and case law suggests that it can include a wide range of assets acquired in different circumstances including assets bought by one party before the marriage and assets gifted to or inherited by one spouse. However, this can be a contentious issue for those with much larger assets and also inherited assets. It will be up to the court to determine if the assets are matrimonial property or non-matrimonial property and case law suggests that this is dependent on the facts of each case. Although generally a pre-acquired asset will not be taken into account, it does depend on the financial needs of the parties and other facts such as when the property came into existence, the length of the marriage, how it was treated during the marriage and so on. 8 For adviser use only not approved for use with clients

9 For adviser use only not approved for use with clients The introduction of pension freedom may also have an impact in this area. Dependants, nominees and successor flexi access drawdown can t be subject to a pension sharing order. However, if an adult child was the beneficiary of a large nominees drawdown and then income was withdrawn from that fund to fund family living expenses, it could be that it would be considered a matrimonial asset. Although this scenario existed pre-freedoms for a dependant it would have needed a bereaved spouse in dependant s drawdown to remarry and then get divorced and that was more unusual. However, the likelihood of an adult child divorcing is higher. In this scenario, Jane received the shares through her work share scheme and the cash ISA was paid into from the couples joint account and therefore both Jane and Jack are happy that they are considered matrimonial property. With the help of their solicitors, Jane and Jack have agreed that they will split assets 50/50. They have also decided to share custody of the children 50/50. Jane has agreed to pay 3 out of the 4 days childcare costs as she is the higher earner. Jane will keep the matrimonial home but this means that Jack needs somewhere to live so he will need access to some cash to put down a deposit on a new home. The trade-off for this is giving up some of his final salary pension scheme. The details of the split are as follows; Asset Jane Jack House Jane s pension scheme 105,000 equity 42,000 fund value Jack s pension scheme 70,000 CETV 200,000 CETV Jane s shares 11,500 12,500 Jack s cash ISA 5,000 Onshore bond 11,000 Total 228, ,500 Jane and Jack s divorce what has been decided It has been established by case law that the sharing principle should apply on divorce. This means that assets will normally be divided equally between the two parties unless there is good reason not to do this. The court will consider a variety of different factors though and when children are involved then this will always be the first consideration. Other areas that are considered are length of the marriage, income and financial resources, financial needs, standard of living during the marriage, contribution to the home, care of the children and so on. For adviser use only not approved for use with clients 9

10 Oracle Technical special edition Mechanics of sharing the assets The court order has been granted and the assets now must be physically shared. House The mortgage for the house will need to be changed from joint names to Jane s name. The bank will also have to agree that Jane has the salary to pay the mortgage by herself. As Jane has a reasonable salary then this should be acceptable to the mortgage company. Her solicitor will need to be involved in drafting a new mortgage deed. Jack s pension scheme The scheme that Jack is a member of a private sector defined benefit scheme. Jane can't remain a number of the pension scheme and therefore she must transfer out her share. This means that her financial adviser does not need to be G60 qualified. When the pension trustees receive the Pension Sharing order > they have 3 weeks from receipt to appeal against any order/agreement > they can delay the start of the implementation period until charges are paid or whilst relevant information is outstanding (or whilst an appeal is being decided) > they have 4 months in which to implement the Pension Sharing Order. This implementation period involves discharging the Pension Debit/Credit by way of an internal or external transfer. It is very important that Jane instructs the trustees quickly where she wants the pension money to go. Once the trustees have this requirement satisfied, and any other requirements, then the order can be implemented. Jane s financial adviser advises that her occupational scheme will not allow transfers in so she asks for the transfer to be paid into a private pension. For annual allowance purposes this is not a contribution. Jane s shares and onshore bond A proportion of the shares are being assigned from Jane to Jack and the bond is moving from joint ownership to being owned by Jack. This will not cause a CGT issue as the assignment is not for money or money's worth where the Court has made an Order: > Formally ratifying an agreement reached by the parties that deals with the transfer of assets including the policy, or > For ancillary relief under the Matrimonial Causes Act 1973 (or financial provision under the Family Law (Scotland) Act 1985) which results in a transfer of rights under the policy from one spouse to another. Other issues Expression of wish forms and wills At the point of separation, Jane s solicitor and financial adviser advise her to consider making a will and amending her expression of wish form for the pension scheme to make sure that her wishes are known. In relation to the expression of wish form, a separated spouse is still technically a dependant in HMRC terms. Jane s occupational scheme is set up on a discretionary basis and the scheme administrator will investigate before deciding who should benefit. An up to date expression of wish form will help them with this task. If Jane died she might not want Jack to receive any death benefits and instead the whole benefit be shared between her dependent children. However, she might want Jack to benefit as well as the children as he would have to look after the children and pay all of the childcare. It is important that Jane carefully considers this. When the pension credit moves into the new personal pension which Jane is setting up then she will need to complete another expression of wish form and she should keep it up to date especially when her children reach the age of 23. This is due to the fact that it allows the scheme administrator to offer the full range of death benefits available. If she died with one child over 23 and two children under 23 but no expression of wish form then the two dependent children could receive dependant s drawdown but the child over 23 would only be entitled to a lump sum. Jane also needs to consider making a will. If Jane died without a will before the divorce was finalised then the law of intestacy states that the first 250,000 of her estate and all personal chattels would pass to Jack together with one half of the rest of the estate. This may not be what she would want to happen. If she would like the children to benefit then she needs to decide who should look after the money for them until they are old enough. What can Margaret do to help Jane? High income child benefit tax charge planning Jane s mum, Margaret, has already identified that she has excess income and IHT issues (see Margaret s case study here). Margaret s financial adviser advised that pension contributions for others could be a very valid planning angle as she can use the normal expenditure out of income exemption. Not only will this reduce Margaret s estate for IHT purposes but it works very well for adult children caught in tax traps like Jane. 10 For adviser use only not approved for use with clients

11 For adviser use only not approved for use with clients Although Jane has a reasonable salary she has a great deal of expenditure and additional pension saving could be beyond her means. However, the retirement that Jane envisaged jointly with Jack will be different from the reality of a retirement alone (assuming no future change in her relationship status). Contributions paid into someone else's pension are treated as either exempt or potentially exempt transfers for IHT purposes. For income tax purposes they are treated as if they were made by Jane and not her mum. The gross value of contributions to personal pension schemes are deducted when calculating Adjusted Net Income. For Jane, in addition to the impact on her Child Benefit tax charge, this means additional income as she is a higher rate taxpayer and as such will be able to claim additional tax relief on this contribution via her self-assessment. This will be very beneficial for her and the children. Should the worst happen then Jane s beneficiaries can receive death benefits. For Margaret, there is the added knowledge that Jane won t be able to access the funds until she is at least normal minimum pension age. This gives Margaret additional control but also means that she knows that Jane has some money for her future bank account. However, Margaret should not make this pension contribution for Jane until there is a separation agreement in place so that this additional pension is not taking into account during the divorce proceedings. Margaret Facts Estate in excess of Nil Rate Band Want to do IHT planning Problem IHT liability Solution Write cheque for 3,938 (or per month direct debit) Impact IHT saving 3,938 x 40% = 1,575 Benefit Lowered IHT liability Passed on more wealth Inheritance Tax Child Benefit Relief at Source Higher Rate Relief Total Plus Initial investment of 3,938 = Jane Facts ANI 54,923 (reduced due to division of dividends) Child Benefit for 3 children Problem Limited disposable income Retirement funding shortfall Child benefit tax charge 1,225 Bank Balance after income tax and child benefit tax charge 4,923 1,969 1,225 = 1,729 Solution Receives 3,938 net pension contribution Impact Pensions Margaret paid 3,938 Basic Rate Tax Relief 985 Amount in Pension 4,923 Bank Balance Previous 1,729 Child Benefit Tax saving 1,225 Higher Rate Relief 985 3,939 Benefit Additional pension of 4,923 Additional Income 2,210 Money for today and tomorrow. Family Tax Saving 1,575 1, ,770 8, % relief from an 3,938 cheque! For adviser use only not approved for use with clients 11

12 Oracle Technical special edition Jane s tax calculation post pension contribution Income Savings income Dividends Total Income Salary 58,000 58,000 Child benefit 2,501 2,501 Dividend income Dividends Total 60, ,904 Personal allowance (11,500) (11,500) Pension contribution paid gross under net pay scheme (3,480) (3,480) Child benefit tax free (2,501) (2,501) Taxable 43, ,423 38,422 taxable 20% (band increase by gross value of additional pension contribution) 7,385 7,684 4,597 taxable 40% 1,839 1, % 0 0 Child Benefit tax charge 0 0 Tax payable 9, , For adviser use only not approved for use with clients

13 For adviser use only not approved for use with clients Tax relief on pension contribution relief at source Jane s pension contribution to her occupational scheme receives tax relief via the net pay method. However, she will receive tax relief via the relief at source method for the contribution made on her behalf to the personal pension. This means that it is paid net of basic rate tax relief to the scheme and the scheme administrator claims basic rate tax relief from HMRC, which is paid directly into the scheme. It can take up to 10 weeks for the provider to receive the basic rate tax relief from HMRC. However, many large schemes/providers will usually gross up the contribution immediately at the time the net contribution is received. As Jane is entitled to higher rate tax relief she must claim this from HMRC via self-assessment. In contrast to Net Pay, contributions paid under Relief at Source do not reduce the individual's earnings before tax is calculated. The individual's earnings will be subject to deduction of tax in full. The additional tax relief is given by extending the basic and higher rate tax bands by the amount of the gross pension contribution. For Jane, this means instead of having 33,500 in the basic rate band there is 38,422 and instead of having 9,520 in the higher rate band there is 4,597. Child benefit calculation Adjusted net income (for allowance/benefit purposes) 50,000 Income in excess of limit 0 Excess in multiples of Number of children 3 Child benefit 2,501 Child benefit tax charge 0 Net child benefit 2,501 Total income 60,501 Dividend income 403 Tax payable (9,523) Child benefit tax charge (0) Summary Going through a divorce is a difficult time emotionally and financially. Legal advice is crucial at the point of the divorce but financial advice is also necessary and good financial advice will have an impact for years to come. For Jane this means help in dealing with the additional pension which she will receive from Jack, making sure that the assets are dealt with correctly when they are split and thinking about her retirement plans and what might happen if she died. Contributions from her mum towards her pension scheme will help with her retirement income need, reduce her tax bill, retain the full benefit of her child benefit but also will help her mum Margaret to reduce her estate which will be subject to IHT. For adviser use only not approved for use with clients 13

14 Oracle Technical special edition We have lots more support available that can help you when engaging with clients like Jane. A Prudential Account Manager will be able to take you through everything we have, but here are some key items now: Pensions and divorce facts Taxation of bonds Tax relief modeller Child benefit tax trap planning Pensions and divorce one year on TIMETOTALK - INVESTMENT PLANNING - 14 For adviser use only not approved for use with clients

15 For adviser use only not approved for use with clients Trustee duties and responsibilities background Jane s mother, Margaret, is recently widowed after the death of her second husband (Victor). Margaret s first husband, who was Jane s father died many years ago. Margaret has therefore been widowed twice and on both occasions she fully inherited meaning that the nil rate band (NRB) of each deceased husband was 100% unused. In situations such as this where there is more than one marriage, the survivor s NRB (i.e. Margaret) can never be increased by more than 100%. Her financial adviser therefore recommended that she implement a deed of variation following Victor s death. Accordingly, Margaret will vary away 325,000 inherited from Victor into a discretionary trust. In brief the implications for Margaret are > She can be a potential beneficiary > Her estate is reduced by 325,000 but for IHT purposes it is treated as if Victor had set up the trust > Her estate will still benefit from a double NRB due to the fact that her first husband s NRB was 100% unused In effect three NRBs will be utilised. Margaret will be the first named trustee and she has asked Jane to be a co-trustee. The potential beneficiaries of the trust will include Jane, her siblings, Margaret and Margaret s various grandchildren. The initial assets of the trust will be as follows AIM shares 15,000 Savings OEICs 80,000 Equity OEICs 220,000 Cash 10,000 Total 325,000 Jane has limited experience of financial matters and no experience whatsoever of trusts. She has a lot on her plate going through a divorce while juggling a busy job with three young children. She is honoured but apprehensive at the prospect of taking on the commitment of being a trustee and has therefore asked for advice on her responsibilities. Margaret also has concerns that being a trustee will be onerous. Trustee responsibilities can be split into five main categories as follows: > Duties to be performed on appointment > Investment duties > Protecting the interests of beneficiaries > Keeping accounts and records > Distributing property to beneficiaries. For adviser use only not approved for use with clients 15

16 Oracle Technical special edition Duties to be performed on appointment 1. Obtain a copy of the trust deed and read it. The trust deed will set out the powers and duties the settlor has given to the trustees. These powers will be dispositive (how, and in what circumstances, the trustees are to distribute trust income and/or capital) and administrative (how the trust is to be run.) 2. Check and understand the interests of beneficiaries. The trustees must act solely in the interest of beneficiaries. The beneficiary has a right to have the trust administered, the trust fund invested and income distributed in accordance with the terms of the trust. A beneficiary who is of full age (generally 18 in England, Wales and Northern Ireland and 16 in Scotland) should be told of his or her interest in the trust. 3. Ensure that the trustee has been validly appointed and that the trustees are legal owners of all the trust assets. The trust deed will set out a mechanism for the appointment of trustees. This mechanism must be followed if it stipulates that the appointment must be by way of deed then a duly executed deed is essential. The investments comprising the trust fund should be in the name of the trustees. 4. Manage where appropriate Certain parts of the trust fund might require management. For example, in the case of a property which is let out then the trustees need to ensure that rent continues to be received, the property is adequately maintained and so on. 5. Ensure that the trust fund is invested. It is a fundamental duty of trustees to invest the trust fund so that the beneficiaries interests (whether in terms of income or capital appreciation) are enhanced. The duty of the trustees in relation to investment is to use their powers in the best interests of current and future beneficiaries. Trustees should also consider whether they are under any duty to sell any part of the trust property. Investment duties Trustees can access a wide range of potential investments. Which particular product, or combination of products, is used depends on the specific requirements of each trust. A trustee must from time to time review the investments and consider whether having regard to the standard investment criteria, investments need to be varied. The standard investment criteria are: > the suitability to the trust of the investments (both in relation to the suitability of the kind of investment, and the suitability of the particular investment); and > the need for diversification of investments of the trust, in so far as is appropriate to the circumstances of the trust. What are the trustees duties in relation to investment? Trustees must invest the trust fund and not simply sit on cash. Assets must be acquired (or retained) to produce a financial return for the trust. [Stone v Stone (1869) 5 Ch App 74] Trustees have a duty of care. The duty of the trustee is not to take such care only as a prudent man would take if he had only himself to consider, the duty is rather to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide. [re Whiteley) (1886) 33 ChD 347] And on further appeal to the House of Lords Business men of ordinary prudence may, and frequently do, select investments which are more or less of a speculative character; but it is the duty of a trustee to confine himself to the class of investments which are permitted by the trust, and likewise to avoid all investments of that class which are attended by hazard. [ App Cases 727] The duty of the trustees in relation to investment is to use their powers in the best interests of current and future beneficiaries. In the case of a power of investment, as in the present case, the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the Investments in question; and the prospects of yield of income and capital appreciation both have to be considered in judging the return from the investment. [(Cowan v Scargill) [ WLR 501] 16 For adviser use only not approved for use with clients

17 For adviser use only not approved for use with clients Trustees should obtain the best rate of return regardless of their own, or the beneficiaries, political, social or moral views. Trustees have a duty to seek proper advice unless he/she concludes that in all circumstances it is unnecessary to do so. Protecting the interests of beneficiaries Trustees must act impartially between the beneficiaries and ensure that one beneficiary does not benefit at the expense of another. Consider for example an interest in possession trust where one beneficiary is entitled to income with others entitled to capital on the death of that person. Those competing beneficiaries should be treated fairly unless perhaps the settlor had made it clear that one class of beneficiary was to be preferred over another. A trustee must not place himself or herself in a position in which his or her duties as a trustee conflicts with his or her private interests. The trustees can only act within the terms of the trust deed. If they act outside those powers they are said to be in breach of trust. A breach of trust will cause some detriment to the beneficiaries. As trustees can only act in the interests of their beneficiaries a newly appointed trustee is obliged to check that there have been no previous breaches of trust. If there have been such breaches the situation must be remedied. The beneficiaries may absolve the trustees from responsibility for the consequences of the breach. Otherwise the trustees have to make good any loss to the trust fund from their own resources. A trustee has a general duty not make any profit from the fact that he or she acts as trustee. Nevertheless, professional trustees may charge for their services in a number of circumstances > Where there is an express charging clause on the trust deed > In certain circumstances with the written agreement of the other trustees > Where appropriate with the prior agreement of all the beneficiaries Keeping accounts and records HMRC make it clear that a record of trust income and expenses must be kept to complete the trust and estate tax return and pass information to beneficiaries. The HMRC guidance details > Records that must be kept > Records of income payments to beneficiaries > How long to keep records > What happens if records are lost or destroyed Clearly a non income producing insurance bond will simplify the accounting and record keeping requirements. Distributing property to beneficiaries In a discretionary trust the trustees will have a power to accumulate income. Accumulation is the process whereby, under the terms of a trust, the trustees are authorised or required to accumulate income, thereby converting it into capital. In interest in possession trusts the beneficiary (or beneficiaries) having the right to income must receive that income within a reasonable period of the trust s accounting year end. The beneficiary will need to include this income in his or her self-assessment tax return so needs to know the quantum of income fairly promptly. The solution Although the checklist of responsibilities is daunting at first sight, Jane and her mother recognise that a number of these duties are simply common sense such as reading the trust deed, acting in the best interests of the beneficiaries, and not acting outside of their powers. They are less comfortable though with investment duties, keeping accounts and records, and dealing with trustee tax returns. The concerns of Jane and her mother are alleviated after they obtain advice from a financial adviser as follows. The trustees (Jane and her mother) could continue to hold the above investments but these investments will produce income meaning that trustee tax obligations will arise. Moreover, the trust will be settlor interested for income tax purposes because Margaret is a potential beneficiary. This means that Margaret is taxable on the income arising even if she doesn t receive it. The trustees will receive the income and be taxed on it, and then Margaret will get credit for that tax paid to set against her own income tax liability. This all sounds very complicated to Jane and her mother. For adviser use only not approved for use with clients 17

18 Oracle Technical special edition Their financial adviser points out however that they don t need to stick with the current investments, and in fact they have wide investment powers in their capacity as trustees. The adviser draws their attention to a fund which is available in an insurance bond wrapper which aims to protect the trustees against some of the ups and downs of the markets by using a smoothing process. This fund spreads investment risk by investing in a range of different assets. The prospect of less volatile and more stable returns over the medium to long-term from diversified assets is appealing to Margaret & Jane who are looking for a peace of mind investment. This investment sits squarely with their responsibilities to take such care as an ordinary prudent person would take when investing for other people. The adviser explains to them that an added advantage of an insurance bond is that it is a non income producing investment which will avoid the cumbersome settlor interested income tax rules for self-assessment purposes. The adviser explains to them how the 5% rule applies to trustees and the option in the future of gifting segments to beneficiaries (children and adult grandchildren) to access their personal tax position upon a subsequent encashment. The younger grandchildren might not require funds for a considerable period of time, and at that time they might be nontaxpayers (part time workers, students?). Margaret & Jane decide to encash the existing investments which they can do in this situation with no capital gains tax liability and invest the proceeds in two insurance bonds; one onshore and one offshore. The offshore bond is nominally earmarked for the younger grandchildren with the onshore bond nominally earmarked for the more mature tax paying adult beneficiaries. In conclusion, Margaret and Jane are happy to act as trustees and come to enjoy the responsibility of preserving and safeguarding the trust fund for the benefit of the potential beneficiaries, young and old. 18 For adviser use only not approved for use with clients

19 For adviser use only not approved for use with clients The detailed case study exploring Margaret s planning options after Victor s death is available here. This considers trustee investment, and other tax matters in more detail The basic principles to follow when acting as a trustee (ICAEW) practice-management/acting-as-a-trustee Types of trust (HMRC) TIMETOTALK - ESTATE PLANNING - For adviser use only not approved for use with clients 19

20 Prudential Distribution Limited is registered in Scotland. Registered office at Craigforth, Stirling, FK9 4UE. Registered number SC Authorised and regulated by the Financial Conduct Authority. GENM /2017