A Monthly Publication

Before getting into this month's subject, I think it's worth pointing out that the doom mongers who predicted a double dip recession seem to have got it wrong and so far the recovery in investment markets has pretty much followed the timescale that I predicted in earlier columns.

Germany, France and Japan have all emerged from recession in the last quarter and the US looks likely to do so in the next quarter, although the UK economy, while improving, is still a little behind due to our very small manufacturing base. However, with cash rates still very poor and likely to remain so, now is very much the time for you to be sitting down and planning your investment strategy if you are to maximize your returns. Don't miss the boat!

Continuing the theme of trust planning from last month's article, I thought it was worthwhile to revisit a solution to the problem of Inheritance Tax (IHT) planning while giving access to capital which has tended to be overlooked in recent years, namely the Flexible Reversionary Trust (FRT).

Often referred to as Reversion to Settlor trusts, they are broadly similar to the more common Discounted Gift trust (DGT) in that a gift of capital is made into a trust, usually via a series of single premium offshore bonds with multiple lives assured, and in both cases the creator of the trust can enjoy an income, but there are in fact a number of key differences.

The two main ones are that, whereas a DGT will only work effectively to reduce IHT if the creator takes and spends a regular income (as to keep it would actually worsen the IHT position, the FRT allows for income to be taken at whatever times suit the settlor, and, secondly, whereas the DGT only allows for part of the initial transfer to fall immediately outside the estate, the FRT allows the full transfer of value to fall completely outside the estate as long as the creator of the trust survives for seven years.

The requirement for the creator of the DGT to take and spend a regular income creates a significant degree of inflexibility, as the income level must be chosen at outset and once established cannot be amended. As a result the trust cannot adequately adapt to changing circumstances. It is also impossible for the trustees to assign benefits to the beneficiaries until after the creator is dead, which could create big problems in the future.

The FRT neatly solves this problem by allocating wide powers to the trustees appointed by the creator. Under this type of trust the trustees can decide when to pay benefits to the creator or defer them indefinitely. As a result of this trustees discretion, the extension of the maturity date of a policy is not treated as a transfer of value and the trust creator's right to receive the future maturity proceeds has no value in the eyes of HMRC as there is, in fact, no “right” because the trustees could decide against making the proceeds available to the creator. This has the effect of allowing the creator to receive policy maturities without any detrimental effect on his (or her) estate for IHT purposes.

Probably the best way to illustrate this is via an example. Brian invests £100,000 into an offshore bond which is split into 100 segments (this could also be achieved by setting up a series of individual endowments), with the intention of of encashing 10 segments or policies every year for 10 years to generate an income. Each year the trustees (and I would always suggest that at least one should be a solicitor) decide whether to exercise their powers to encash or defer the maturities in line with Brian's income requirements. After seven years the whole of the original investment falls outside the Brian's estate but the full value of each policy or segment, including any growth, can still revert to Brian. In effect, what has been achieved is the creation of a long-term vehicle with the flexibility and IHT efficiency of a DGT but with much better access to capital and growth for Brian.

The fact is that no other trust type offers the FRT's mixture of IHT mitigation, planning flexibility and potential access for the creator, and anyone considering a DGT or Loan trust would do well to carefully evaluate whether a FRT might better suit their purposes.

As ever, I must stress that trusts are complex instruments, so always take professional advice before setting one up.