The use of pilot trusts in estate planning is a simple way of passing assets on to chosen beneficiaries more effectively and minimising the on-going taxation implications.
Pilot trusts are often seen as instruments for receiving death in service benefits or insurance policies to avoid these payments being made directly to a surviving spouse and therefore forming part of their taxable estate on death (while allowing them access to the funds as a beneficiary during their lifetime).
It is becoming more common for people who do not have such policies to still create one or more pilot trusts to receive their estate on death. The settlor creates the discretionary lifetime settlements with a nominal amount of cash (normally £10) with the intention that further assets are left to the trust under the terms of their Will.
This is particularly useful where the funds that will be left by the Will are in excess of the nil rate band. If this is the case a number of trusts are created during the settlor's lifetime to each receive a sum below the nil rate band and allowing for growth of the assets. The trusts are set up on different dates to avoid them being classed as 'related settlements' under the Inheritance Tax Act. By doing this you ensure that each trust will then have its own nil rate band and will not be subject to on-going anniversary and exit charges to IHT.
If a testator did not create the trusts during his lifetime and instead just left his estate to one, or a number of trusts created under the terms of the Will, the trusts would be classed as related settlements and there may be substantial IHT anniversary charges. This is because the trusts would be created on the same day, the date of death.
The amount of IHT payable on a discretionary trust's ten year anniversary depends on three factors:
- The cumulative total of the settlor at the date of creation (ie how much he has already given away in a seven year period)
- The value of assets after creation in any related settlements
- The value of the assets in the trust before the anniversary
Because the amount transferred into each pilot trust on creation is a nominal fee (£10) the cumulative total transferred should fall within the settlor's annual exemption.
Pilot Trusts can be set up easily and quickly and it can be done at the same time as a Testator drafts their Will.
HMRC will need to be notified of the trust's existence but whilst the property in the settlement is comprised of cash below £1000 and all the trustees are UK resident, no further Inheritance Tax returns will need to be submitted. The Pilot Trust documents can therefore be stored with the settlor's Will until such time as it is needed.
What are the advantages of Pilot Trusts?
Your assets can still be available for your use during your lifetime. This is because you can provide for the gift of the assets to the trust by the terms of your Will. This gift will only take effect on your death. You can place assets in these Trusts at any point during your lifetime or by your Will. The assets can be used for your surviving spouse's benefit but also preserved for your children and grandchildren. You can include a Nil-Rate Band discretionary trust in your Will and leave further monies to the Pilot Trust by your Will. Although there would be IHT to pay on your death, those further monies (if under the NRB) would not be subject to IHT on the 10-year anniversary charge. Thus you would have the advantage of 2 Nil-Rate Bands. All the monies in the trusts would not be part of the surviving spouse's estate but would be available for their use during their lifetime.
Because all the assets placed into the Trust by your Will do not belong to the surviving spouse, they are protected from inclusion in Local Authority calculations for Nursing Home Fees.
There is no transferable nil rate band available for surviving cohabitees. However monies up to the nil rate band can be added to the pilot trust via the Will and then the residue also left to the cohabitee for life. There will be two trusts of monies created but they will not be related trusts. This means that all the assets are available for the surviving cohabitee during their lifetime but are also preserved for your children or other beneficiaries. All monies in the trust remain under the nil rate band for at least the first ten years and therefore there will be no IHT to pay. Funds in the discretionary trust can also be made available for children before the cohabitee has died.
Protection of Assets
All assets placed into one or more discretionary trusts are protected from the changing circumstances or whims of your beneficiaries, for example Divorce/Re-marriage - if a beneficiary divorces, the assets in the trust cannot be included in any divorced settlement. Conversely if your spouse re-marries, whilst the assets in the trust are still available for their use during their lifetime, they are protected for your own children and wider family Bankruptcy - if one of the Beneficiaries becomes bankrupt, the assets in the trust cannot be taken by their Trustee in Bankruptcy to pay their debts Nursing Home Fees - if your surviving spouse/cohabitee has to go into a nursing home, the assets held in the trusts cannot be included as part of the Local Authority calculations towards your fees. This means that you could protect more assets than those in a Nil-Rate Band Trust providing the other trust was set up using a Pilot Trust.
Trusts for Grandchildren
You can set up individual trusts for each grandchild, using pilot trusts. Providing each pilot trust was set up on a separate date and the amount invested in the trusts is together below the nil-rate band, then there should be no IHT to pay at the first 10- year anniversary or any exit charges prior to the 10-year anniversary. Initially you would want to invest a small amount and add to it later either during your lifetime or by Will. If you create one trust for all your grandchildren, and the total value gifted is over the nil-rate band and there will be IHT to pay initially and at the 10-year anniversary.
Death-in Service Benefits
Often a person can nominate their death in service benefit to pass directly to their surviving spouse/cohabitee on their death. If this is set up correctly by the pension trustees, that amount will fall outside their estate, for Inheritance Tax purposes.
However, that money will increase the surviving spouse/cohabitee's estate on their death. A pilot trust could be set up and the nomination made to pay the death in service benefit to the Trustees of the Pilot Trust. The monies will then fall out of your estate on your death but not be part of the survivor's estate on their death either. The monies will be available for the survivor's use during their lifetime but protected from both Inheritance Tax, Nursing Home fees and affords the fullest flexibility available.
This document does not constitute legal advice in its own right, always consult a solicitor for tailored legal advice.