How to Use an Asset Protection Trust to Keep Your Wealth in the Bloodline

It’s a sad fact that 42 percent marriages end in divorce. Your children won’t be immune to that statistic. That means that the wealth you’ve worked so hard to build up over the years is at risk of being taken by people who leave your family. The assets that you’d planned to pass onto your grandchildren gone. That’s where an asset protection trust comes in.

Trusts may sound like a nice to have feature of your estate plan. But if you’ve wealth you want to keep it in the bloodline, it’s important to consider setting one up.

And it’s not just divorce that can cause your wealth to disappear after your death. Remarriage of your spouse can bring new children-in-law into your family that could have an equal claim on your estate alongside your direct descendants.

Further, gifts that you make to your children whilst you’re still alive are also at risk. Giving money or assets to your children to avoid inheritance tax liability may sound like a good idea; particularly if the gift is made seven years or more before death. However these gifts could also be lost to separating partners.

So, what is an asset protection trust? And how does it work?

An asset protection trust is like a business

An asset protection trust is a separate legal entity into which you transfer the wealth or assets you wish you protect. Property, antiques, investments and other chattels are the obvious items to consider, but in theory you can put anything into trust. The trust then has legal ownership of these assets which it can give, sell or lend to anyone within its remit. Generally it would be your spouse, children and grandchildren who would benefit from the trust.

In fact, once set up, trusts can last for up to 125 years so the assets you put into the trust could be used for the benefit of 3 or 4 future generations.

So who controls what happens to the assets you’ve transferred? Well, you do.

When setting up the trust you get to choose who you want that trust to benefit. It might be that you just want a single person to benefit. In which case the trust will be an Immediate Post Death Interest trust (IPDI). Or, alternately, you can establish a discretionary (or absolute) trust which gives power to the trustees to use the trust’s assets to benefit a number of individuals or groups of people (children and grandchildren, for example) in line with the guiding principles that you establish at the outset.

You get to appoint the trustees so that you can be confident that your wishes will be carried out. Initially, you and your spouse would likely be the trustees, which is ideal if you make gifts during your lifetime. You may wish to appoint your children as each of you dies.

Protecting your estate from unwelcome claims

The power of the trust comes into play when the assets get put to use.

Were your trustees to simply “give away” the trust’s assets (i.e. your estate) to the beneficiaries there would be no material advantage in terms of protecting your wealth for future generations. If your grandchildren were to marry and then divorce their estranged partner would have claim to the assets gifted from the trust.

However, no claim can be made against an asset protection trust by the estranged party. So, by the trust lending the money for your grandchildren to buy a house instead, they can get the benefit of the cash without putting that capital at risk during a breakup. The money can be loaned interest free for live, or with interest. You can provide guidance to the trustees in this respect if you wish.

42-percent-of-marriages-will-end-in-divorce

The trust can also buy and own the property (or any other asset such as equities) and let the beneficiary have use of the asset during their lifetime. Future gains in the value of the property therefore take place within the protected environment of the trust and are kept available for future generations.

Both loan and purchase approaches have further benefits.

Because the assets remain in the trust they will not form part of your beneficiaries’ estates and are therefore protected from second generation inheritance tax, claims by local authorities for care costs and third party creditor claims in the event of bankruptcy.

Stopping the taxman from taking your assets

Many people use so called “will trusts” that come into effect only on death. However, doing so guarantees your estate WILL BE assessed for inheritance tax.

Your trust will be liable for IHT chargeable at 40 percent on assets over the first £650,000 that you and your spouse collectively bequeath, called the nil-rate band.

The government is introducing an additional “Family Home Allowance” of £175,000 which will be phased in between 2017/18 and 2020/21. This will effectively create a combined £1 million allowance for couples.

There is however a sting in the tail. Estates worth more than £2 million will see the Family Home Allowance tapered off at a rate of £1 for every £2 over the £2 million threshold. Estates worth £2.6 million will therefore not benefit from any Family Home Allowance meaning all but £650,000 of the estate will incur IHT.

Creating the trust whilst you’re still alive may avoid this issue.

Giving an asset into a living trust is a Potentially Exempt Transfer (PET) and will not be assessed for IHT if the gift is made seven years or more before death. After that a taper relief applies. The shorter the window between the transfer and death, the higher the percentage of the gift that is assessed for IHT:

Time elapsed between gift and death Reduction in assessed IHT on gift
< 3 years Nil
3-4 years 20%
4-5 years 40%
5-6 years 60%
6-7 years 80%

Setting up an asset protection trust and transferring your assets sooner rather than later should therefore be considered.

Asset protection trusts and capital gains tax

Because trusts are their own legal entity, they do not benefit from the personal allowances – either yours or your beneficiaries.

Thus any gains realised within the trust will be assessed for CGT. Selling your family home once it has been placed into the trust, for example, would no longer be exempt. Any gains from the market value at transfer will be liable to CGT.

Caution therefore needs to be exercised when deciding what assets to place into trust and when.

Are you concerned with bloodline planning? Do you think asset protection trusts are over the top, or a sensible insurance policy? Let me know your thoughts in the comments section below.

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About the Author

By Nigel Reeves: My mission is to provide the quality, honest & jargon-free pension advice that people need to secure the retirement they deserve. At home, I'm a family man and an active supporter of grassroots sports!

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