Techzone

Investment powers

Most modern trusts give trustees wide investment powers allowing them to invest in any type of investment. They still have to take into account the goals of the trust and what is considered prudent. This will include investments in life assurance products, unit trusts, OEICs, shares, deposits and property.

However, it's possible for the trust deed to include some investment restrictions. It's important to check the deed before making any investment decisions. Legal advice should be obtained if the trustees are unsure of their powers.  

Statutory and other investment powers

There are statutory investment powers if there are no investment powers within the trust wording. These also give the trustees wide powers of investment.

The statutory powers relating to investments are laid out in the;

• Trustee Act 2000 for England and Wales
• Charities and Trustee Investment (Scotland) Act 2005
• Trustee Act (Northern Ireland) 2001 

These investment powers also apply to trusts created as a result of intestacy, for example when a parent dies without making a will and the estate is payable to their minor child.

The three Trustee Acts, allow the trustees to delegate investment decisions to a discretionary fund manager (DFM). If they choose to delegate, they must provide the DFM with an investment policy statement. There is no set format for this statement but it must guide the manager when exercising discretionary powers. This is not a legal requirement in Scotland but would still be good practice.

Some trusts state the STEP (Society of Trust and Estate Practitioners) standard provisions have been adopted. These provisions also give the trustees wide investment powers.

Investment considerations

When selecting investments the trustees should act in the best interests of all classes of beneficiaries of the trust. In England and Wales, the Trustee Act 2000 introduced a statutory duty of care for trustees. This includes a duty to apply the 'standard investment criteria' and a duty to obtain proper advice when making or reviewing investments. 

The standard investment criteria requires that trustees ensure any investment proposed is both suitable for the trust and where appropriate  it has regard for diversification of investments. The standard investment criteria can be overridden by the trust documentation, for example the trust may expressly state that the trustees do not need to consider diversification of their investments.

The trustees must also review the investments on a regular basis to ensure they remain suitable for the trust.

Other factors

In addition to the standard investment criteria, the trustees should also consider the following:

• The nature and terms of the trust
• Their investment powers
• The size of the fund
• The need for income or capital growth or both
• When payments to or for the beneficiaries will be required
• The taxation of the investment
• The tax position of the trustees and beneficiaries
• Tax reporting obligations
• Their risk profile
• Cost of administering the investment

Absolute trusts

An absolute trust is frequently used for minor beneficiaries. The beneficiary is entitled to the trust fund and any income from it, and from the age of 18 (16 in Scotland) can demand that the trustees transfer the assets to them. 

If trustees continue to hold assets beyond these ages, they should make the beneficiaries aware of their entitlement as they will need to know for tax purposes, or in other financial situations such as divorce or bankruptcy.

OEICs and unit trusts

Dividend and interest payments from OEICs/unit trusts are taxable upon the beneficiary unless the parental settlement rules apply.  If there are minor beneficiaries with no income this means the beneficiary’s own allowances can be used each year to offset against income distributions. This includes;

• personal allowance
• savings rate band
• dividend allowance
• personal savings allowance 

Capital gains will be assessed upon the beneficiary when there is a disposal. Regularly crystallising gains each year within the CGT exemption can limit the amount of tax payable when the funds are ultimately needed.

Investment bonds

Both onshore and offshore bonds do not generate income. All income and gains within a bond roll up and are taxed under the chargeable event rules. Tax will be deferred until there is a chargeable gain. This means allowances aren’t automatically used each year.

Chargeable gains are assessed on the beneficiary.

• Onshore bond gains carry a notional 20% tax credit which is non-reclaimable. This reflects the tax already paid by the fund. The beneficiary will only have further tax to pay if the gain when added to other taxable income results in higher rate tax becoming payable. Top slicing is available to mitigate any liability to higher rate tax.
  
  
• Offshore bond funds don't pay any further tax on income and capital gains, benefiting from what is often referred to as ‘gross roll-up’. Gains made when money is withdrawn from a bond falling within the beneficiary’s personal allowance, savings rate band and personal savings allowance will be tax free. This allows the potential for gains of up to £18,570 to be taken each year free of tax if the beneficiary has no other income.

The parental settlement rules will apply where a gain arises on a bond in a bare trust set up by a parent for their minor child. This will mean the chargeable gain will be assessed upon the parent but still with the top slicing available.

Once the beneficiary is over 18 a bond can be assigned to them. This will not change the tax position of any chargeable gains but it does allow them to manage the bond themselves.

Types of interest in possession trusts

Interest in possession (IIP) trusts will have a named beneficiary, or beneficiaries, who are entitled to any trust income. These beneficiaries are deemed to have an interest in possession. No beneficiary has an immediate entitlement to trust capital.

The two most common types of IIP trust seen in financial planning are:

• life interest
• flexible power of appointment

The investment considerations may differ for each of these.

Life interest trusts

The life tenant (known as life renter in Scotland) under a life interest trust is automatically entitled to trust income but the capital typically passes to the remaindermen on the life tenant’s death. These arrangements are common in wills with a surviving spouse having a life interest and capital ultimately passing to children.

The trustees need to act fairly between the different classes of beneficiary. They will normally need to strike a balance between providing a suitable income for the life tenant whilst leaving scope for capital growth for the remaindermen. 

OEICs and unit trusts 

Income will ultimately be taxed on the beneficiary with the interest in possession.

The trustees can either:

1. choose to have the income paid directly to the beneficiary. This is known as mandating. The trustees pay no tax on the income and the beneficiary declares it on their own tax return.
2. or they receive the income and pay basic rate tax after deducting any income expenses. The trustees then pay the balance of the income to the beneficiary with credit for the tax already deducted.

Income retains its source nature, for example, dividend or interest. The beneficiary can use their personal allowance, personal savings allowance, starting rate band for savings and dividend allowance against trust income where appropriate. Beneficiaries who are taxed at less than basic rate will normally be able to reclaim any tax deducted. 

The asset mix of the fund will determine whether income is paid as dividend (less than 60% cash or fixed interest) or interest (at least 60% cash or fixed interest). 

The trustees cannot accumulate income within the trust and therefore they should invest in income units and not accumulation units.

Capital gains within the trust will be assessed at the trust rate of 20%, for disposals before 30 October 2024,  with a maximum annual exemption of £1,500 (2024/25)  (£3,000 2023/24), half the amount applying to individuals.  From 30 October 2024 the trustee rate of CGT has increased to 24%.

Transferring assets to a beneficiary will be a disposal for CGT, but it may be possible to defer the tax by claiming CGT holdover relief in certain circumstances.

On the life tenant’s death the capital typically becomes held on bare trust for the remaindermen. There may be no CGT payable on the life tenant’s death on certain life interest trusts.
 
Qualifying interests in possession, which include pre 22 March 2006 trusts and immediate post death interests (IPDIs), will benefit from CGT free uplift on death. This means the remaindermen’s acquisition costs for CGT will be the market value at the date of the life tenant’s death.

Investment bonds 

As investment bonds are non-income producing assets they may not be a suitable investment for this type of trust.

All bond withdrawals are a payment of capital not income. Trustees making regular withdrawals to the life tenant run the risk of being in breach of trust by advancing capital to a beneficiary who may only be entitled to income. 

This may also be a breach of their statutory duty of care in balancing the needs of the income and capital beneficiaries. Also paying regular withdrawals to the life tenant may mean that the capital payments will be taxed as income in the hands of the beneficiaries. 

However, an investment bond could be used for capital growth as part of a larger portfolio where other assets are used to provide an acceptable level of income for the life tenant.

Flexible power of appointment trust

A flexible power of appointment trust gives named beneficiaries the right to any trust income but unlike a life interest trust there isn’t any requirement to invest in income producing assets. 

This type of trust was commonly used before 22 March 2006 as gifts to this type of trust at that time were potentially exempt transfers rather than chargeable lifetime transfers and periodic and exit charges didn’t apply. 

The trustees have a power of appointment. This means that the trustees have the power to select beneficiaries, from a wide class of beneficiaries, to receive income or capital. Any beneficiary who has the right to income is deemed to have an interest in possession and if this was a pre 22 March 2006 trust, they would have the value of the trust fund included in their estate.

OEICs and unit trusts  

The taxation of OEICs and units trusts mirrors that of a life interest trust (see above). 

Investment bonds  

A bond can be a suitable investment for this type of trust if capital growth rather than income was required. 

The normal trust taxation rules don't apply to bonds in trust. The chargeable event rules mean that any gains are assessed upon the settlor if they are alive and UK resident. They will have the benefit of top slicing to limit any exposure to higher or additional rate tax. 

Gains which arise as a result of the settlor’s death or where the bond is surrendered in the tax year of death will continue to be assessed upon the settlor.

Any gains which arise in a tax year after the settlor’s death will generally be taxed upon the trustees at the trust rate of 45%. But the trustees may decide to assign the bond or segments to the beneficiary. This will allow gains to be assessed upon the beneficiary. 

Gains may escape tax completely where a bond was taken out before 17 March 1998 and where the settlor also died before this date. This was known as the dead settlor trick and can still apply provided the bond has not been altered in anyway. 

Using investment bonds can also reduce the admin burden for trustees. No tax returns are needed until there is a chargeable gain.

Discretionary trusts

Under a discretionary trust no beneficiary has an automatic entitlement to trust income or capital. The trustees have discretion over who to make payments to and when. The trustees will need to decide if they want trust income to be distributed to a beneficiary or retained within the trust. 

OEICs and unit trusts   

Income from a unit trust or OEIC held in a discretionary trust will be taxable upon the trustees.

Income will be paid either as a dividend or interest depending upon the asset mix of the underlying fund. All income will be paid as a dividend if the fund contains less than 60% cash and fixed interest. The trustees will pay tax at 45% on interest and 39.35% on dividend income.  From 6 April 2024 the £1,000 standard rate band has been abolished. Instead, trusts with income of less than £500 will have no tax reporting requirements and pay no income tax. The £500 limit will be reduced if there are multiple trusts created by the same settlor.  

Trusts with income over the £500 limit will pay tax on all income received (not just income in excess of the limit).

When income is paid to a beneficiary it loses its source nature; it is no longer dividend or interest and becomes trust income. Trust income is paid with a 45% tax credit and the trustees must have already paid the equivalent amount of tax in order to make the payment. This can be an issue if the trustees wish to distribute dividend income on which tax of 39.35% has been paid.

The trustees may pay CGT when they sell or switch funds. Gains in excess of the trust annual exemption of £1,500 will be taxed at 20% (£3,000 2023/24). From 30 October 2024 the rate of CGT for trustees has increased to 24%. 

Remember that the trust capital gains tax annual exempt amount is shared by any other trusts created by the same settlor. So for example, if a grandparent creates separate trusts for each of their 3 grandchildren then each trust would have £500, to offset against gains.

When the trustees distribute funds to a beneficiary they have two options:

1. encash shares/units in the fund and pay the cash to the beneficiary, or
2. transfer shares or units into the beneficiaries name (if they are over 18).

Both will be a disposal for CGT. However, where shares/units are transferred to the beneficiary it is possible to jointly elect for holdover relief. This will defer any gain until the beneficiary makes a disposal. It also means the beneficiary can use their own full CGT allowance and any gains which fall which fall within basic rate will be taxed at 10% rather 20%. From 30 October 2024 gains which fall within basic rate will be taxed @ 18% .

Payments of capital either as cash or as a transfer of shares/units will be an exit for IHT. Typically tax will only be payable if:

• there was tax to pay at the last periodic charge date, or
• if capital is paid out before the first 10 year anniversary, the initial value of the  trust was greater than the available nil rate band.

Investment bonds   

The taxation of investment bonds held in a discretionary trust mirror the position of flexible power of appointment trusts (see above).