Technical briefing - 11 April 2014

The investment challenges of trusteeship

As a trustee, you are not only responsible for administering a trust, but also for ensuring that trust assets are properly managed. This often involves ensuring that the right investments and advisers are in place.

Guest author: Alexandra Loyden

Head of Private Client, St James's Place Wealth Management

The challenges trustees face are wide-ranging. These challenges might include discerning how to successfully invest the trust fund to meet the needs and interests of different beneficiaries; satisfying income requirements whilst preserving capital; matching portfolio risk with the needs of the trust; and choosing whether to invest onshore or offshore.

Historically, trustees have delegated responsibility for the investment of trust funds to stockbrokers in the belief that they were the professionals most suitable to provide the required investment advice. Indeed, the courts encouraged them to take this view, However, in recent years, stock market events have led trustees to focus on gaining greater diversification than that typically available through stockbrokers.

Since the turn of the century, we have experienced several world events that have dramatically affected stock market values. Increasing recognition of the potential value of a diversified investment portfolio has led to the word ‘diversification’ becoming embodied in legislation. For today’s trustees, the question of how best to achieve diversification across different asset classes within a portfolio is at the forefront of investment discussions.

Just as diversification has become a priority for trustees, so too have tax efficiency and fees. So how should trustees balance these priorities? Given that beneficiaries are resident right around the globe, it could be tempting to conclude that structuring a trust tax efficiently, whilst also meeting everyone’s needs, has become impossible. Yet that is simply not the case.

No matter the size or investment objectives of the fund itself, or its onshore-offshore composition, appropriate solutions do exist. For many trustees, that solution might be an investment bond. The bond, together with the funds it contains, can provide income, capital growth or a mix of the two. An investment bond can be onshore or offshore, and trustees are entitled to withdraw up to 5% of the original investment value annually, without creating a tax liability. These bonds are particularly suitable as trustee investments when the beneficiary is a UK taxpayer.

The use of investment bonds can overcome the complex treatment of income, particularly within discretionary trusts. Beneficiaries can potentially receive the return of 100% of the capital invested tax-free, without annual tax charges on the growth. However, to achieve this outcome, the trustees must not withdraw in excess of the 5% capital allowance in any one year, since that could trigger an Income Tax liability. UK beneficiaries should take particular care to ensure that no foreign income or chargeable gains exist within the trust. In the event that they do, the 5% allowance may not be eligible for tax deferral.

The tax case for investment bonds as a trustee investment has been strengthened further since the dividend allowance of £5,000 (to be reduced to £2,000 next April) was denied to trusts.

It has been suggested that regular payments of capital to beneficiaries could be regarded as income and taxed as such in their hands. However, the case of Stevenson v Wishart  is instructive here. Under the terms of a discretionary trust, trustees made payments for a beneficiary’s nursing home expenses out of trust capital. HMRC confirmed that these payments did not create an entitlement or right to income. Had the trust been structured so as to produce a natural income, such as through direct investment into shares, then Income Tax would have been payable.

So whatever the size of trust, tax-efficient trustee investments are available, particularly for beneficiaries resident in the UK. These investments don’t create annual income or capital gains, either of which would need to be reported, and they can be structured to simplify the administration of the trust.  Having considered the tax set-up, trustees’ next question might then be: how can we ensure diversification and manage risk?

The funds available through investment bonds make it easy to diversify the trust investments and, thus, to manage investment risk. A typical range of funds will allow diversification by asset class, geography, market capitalisation –  even by the investment style of the fund managers.

Trustees invest in the life policy, not directly in the underlying funds. As a result, switching does not involve selling one fund and buying another, as it would if you invested using, say, unit trusts. Changing the portfolio to match the evolving requirements of the beneficiaries can therefore be achieved without incurring Capital Gains Tax.  Moreover, since fund switches are not treated as taxable events, no liability to Income Tax arises either.

In short, while an investment bond may not satisfy all a trustee’s requirements, it remains a powerful took, offering significant advantages in a wide variety of circumstances.

Correct as of May 2017.




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