'Asset protection' trusts

The idea behind an Asset Protection Trust (‘APT’) is that, by using an APT, a person (the ‘Settlor’) can transfer an asset to the trust to safeguard that asset from a claim that the Settlor might later suffer.  However, there are problems that should be understood before setting up an APT.

What might the claim be that the Settlor is concerned about?  There are special rules relating to insolvency and bankruptcy to prevent a person in business from hiding assets from creditors.  There are also rules to prevent one party to an unhappy marriage from hiding assets from her or his (soon to be ex-) spouse.  Likewise there are rules to prevent a person from ‘parking’ assets shortly before death in order to prevent ‘unpopular’ dependents from inheriting them.  These are all special situations where the client should of course take detailed and specific advice.  This note is not concerned with such problems.

Far more common is the fear, by someone who is now middle-aged or elderly, that savings and other assets built up over many years might be lost some other way.  The worries are, for example:

• That the funds will be dissipated by family members who are young, profligate, financially illiterate or all three; or
• That the funds will be claimed by the life partners of family members; or
• That the cost of care in later life will exhaust the funds, leaving nothing for family to inherit.

This need not be an issue. The best protection, during the lifetime of the Settlor, is probably to train family members in the habits of good housekeeping and the value of saving so as to have a fund for emergencies (and to top up that fund after raiding it).  For young family members there are several options that are less expensive to set up than an APT.  Get advice.

Funds enjoyed by the children of the Settlor will probably, on any divorce or separation of the child, be subject to claims and the court may well take those funds into account in dividing assets. Putting in place, fairly early in the relationship, some kind of agreement between partners of unequal wealth may seem callous but makes sense.

The Settlor can to some extent protect his children by the way he words his will: get specialist advice.

The Settlor can also use a lifetime gift into trust, if the value is large enough to warrant the trouble and expense. The trust can be worded so as to provide an emergency fund; but where the child receives regular benefits the court will take that into account. Again, take advice.

This is the commonest reason to think about using an APT. The idea is to ‘park’ assets where they cannot be taken into account for the purposes of assessing the means of someone who has to go into care. The problem is that the local authority has wide powers and, with budgets under pressure, is very likely to use them. Put simply, there is power to set aside certain transactions entirely if they were entered into solely to deprive the Settlor of the means to pay for care. There is a lesser power to take into account the value of assets that can be shown to have been ‘parked’ just to save care fees.

The Settlor will, no doubt, argue that there were many reasons for setting up the APT apart from saving care fess, and that, when the APT was set up, she did not need care anyway. The trouble is evidence. For example, was it for tax planning? If the terms of the APT allow the Settlor to benefit from the fund in her lifetime, the APT will be neutral for Inheritance Tax, so the Settlor cannot claim that saving IHT was one of her motives.

All too often, the APT is set up to hold the family home. The Settlor intends to go on living there, rent-free. The APT saves neither IHT nor other taxes, such as Capital Gains Tax: indeed it may even increase tax liabilities. If the stark facts of the case are that the only motivation for setting up the APT was to avoid care fees, and if the Settlor has to move into care fairly soon after creating the APT, there is strong risk of a successful (and costly) challenge.

The practical issues at the outset

To be valid, the trust should be properly constituted.  This means, in simple terms, that:

• The Settlor should be ‘competent’, so (probably) an adult, who has power to deal with the property to be settled;
• The trustees are identified and competent to hold trust assets;
• The beneficiaries are identified with some precision;
• A defined asset is being settled;
• The trust must be established in a way recognised by law;
• The trust must be ‘valid’; and
• The trust must be for a lawful purpose.

Sometimes things go wrong.  For example, husband and wife may own a house jointly.  One of them, say the husband, signs a trust of ‘the house’.  He does not own ‘the house’ but only a share in the proceeds of its eventual sale, so what has he actually settled?  Get advice before spending too much time and money on the project.

Problems can arise where a valid trust has been set up but there has been no ‘follow-through’ in that the asset has not been transferred from the Settlor to the trustees. People often overlook the different role of the trustee. For example, husband died a few years ago and widow now holds a few shares that she wants to set aside for her grandchildren. She and her daughter are trustees of the APT. She must transfer the shares into the joint names of herself and her daughter (and see to it that dividends are received and enjoyed as trust income).

The transfer of assets to a lifetime trust is almost always a ‘chargeable transfer’ for Inheritance Tax. However, in general terms the regulations do not require small trust transfers to be reported. It is only where the assets are substantial (rule of thumb: 80% of the Nil rate Band, so £260,000) that a return must be filed. Another area to seek detailed advice.

More urgent, usually, will be to comply with H M Revenue & Customs Trust Registration Service (‘TRS’). This establishes the HMRC database of trust interests and helps them to tax trusts. Details are required of the settlor, the beneficiaries and the assets in trust. Although it was hoped that trustees could access the TRS personally and lodge all the information online, there have been teething troubles with TRS. Many people will prefer to use an agent to deal with the formalities.

For a time it seemed that nearly all UK trusts would have to be registered in the United States under the ‘FATCA’ rules. Again, this was an online process but many clients and their advisers found compliance difficult. The FATCA rules were mainly designed to enable the US Internal Revenue Service (‘IRS’) to trace US-based tax dodgers but were very widely drawn. As a result, the IRS computer was inundated with registrations that achieved no tax purpose. The rules have been modified somewhat as a result but are still relevant where the trust has a foreign element.

The practical issues whilst the trust continues

Where a trust receives income in excess of £1,000 per year, it is very likely that annual tax returns will be required. The regime is fiddly and can be operated using appropriate software, though many trustees prefer to use an agent who is used to the forms. If properly managed, the actual tax burden is moderate.

If the trustees make gains, again a return will usually be required. Well-advised trustees make modest gains each year to maximise exemptions. Get advice.

Every ten years the issue arises whether IHT is due on the trust fund and whether a return is needed at the ten-year anniversary. As a rule of thumb, a trust that is then worth less than £325,000 (after allowing for capital released in the previous ten years) will probably not need to file a return. The return is quite difficult to complete: HMRC have provided copious guidance notes and calculation sheets but the tax rules themselves are complex, having been designed to cover many different situations. They are so complex, in fact, that the Government has initiated a consultation into the scope for simplification of the rules.

A settlor who has spare assets, such as surplus savings, and who does not mind paying professional fees to do the job properly, may well benefit from using an APT for the benefit, say, of young family members. Assets will be available without waiting for probate.

Someone who:
owns a house that is their (only) home; and
has only modest savings, that might be needed in an emergency;
should leave APTs well alone.