Maria Posiwnycz explains how Discretionary Trusts can be used as a mechanism for protecting the family home from care costs
The moral debate about who should fund long-term care is a hot topic. One of the main factors in the debate centres on using the family home to fund the cost of care.
So is a Discretionary Trust the answer to protecting the family home from care costs? Like all planning the answer is, “it depends”.
First and foremost, the use of a Discretionary Trust should be a solution that specifically fits your circumstances. By ensuring it is specific you will mitigate any challenge by local authorities in the future regarding deprivation of assets – namely, you have an argument that the Trust was not merely set up to avoid care home fees.
The earlier advice is sought and the earlier the Discretionary Trust is set up the better. Further protection is afforded against the argument of deprivation of assets if the trust is set up when you are in good health, and without any expectation of needing the use of care home facilities.
Protecting your assets and the inheritance for your chosen beneficiaries is not in itself a deprivation of assets, but the justification for so doing will be easier to argue where advice has been sought to tailor a plan that fits your individual circumstances; rather than buying into a generic ‘off-the-shelf’ product labelled as “protect your family home from care fees”.
It is good planning to make arrangements to ensure that as much wealth as possible passes to your chosen beneficiaries. Instead of transferring your assets outright, however, making a gift to a Discretionary Trust means that you can retain some control and right to occupation. The Trust will own the property; however, and this will mean you cannot use the capital in your home or use the property to guarantee any loans.
When using the Discretionary Trust route it is important to remember what the objectives are – whilst protecting the family home from care costs, this route may not give the best long term tax consequences.
What is the tax problem?
If you continue to live in the family home rent free the gift to the trust will be treated as a gift with reservation of benefit and the value will be considered in the estate on death.
This ‘problem’ actually presents a further planning opportunity and protection from challenge. Paying rental income to the trust for the use of the home is a win for the estate as this will reduce the value of the individual estate for Inheritance Tax purposes and a win for the trust as the rental proceeds provides the trust with income to maintain the property. Giving the trustees cash with which to maintain the property will further avoid the trust being treated as a sham.
Other tax considerations
The lifetime nil rate band, £325,000, can be settled on trust without a lifetime inheritance tax charge. Anything over this amount will attract a 20% tax charge.
As well as paying tax on net income Discretionary Trusts are assessed to tax on each 10-year anniversary – under current legislation; however, the charge will never be in excess of 6%.
Trust income is assessed to tax at higher rates than an individual would be and trusts have a lower capital gains tax annual exemption.
So if setting up a Discretionary Trust to avoid care home fees is open to challenge by local authorities and the tax rates are higher, why would you plan to use a Discretionary Trust at all?
• Providing for the family: discretionary trusts are a flexible way to provide for a family group with differing need.
• IHT planning: remove the property from the estate for Inheritance Tax Purposes
• Minor children: the asset is owned by the trust
When using this arrangement remember that a trust is a legal relationship that is recognised and enforceable in court. The tax around trusts is a specialist area. It is imperative that the legal and tax implications are fully understood before making this arrangement.
Local authorities have powers to scrutinise any arrangements that they consider may have caused the deprivation of capital. There are no guarantees that the Discretionary Trust arrangement will prevent Deprivation of Capital rules being applied. Protection is afforded, however, by tailoring the arrangements specifically to your circumstances in a timely manner.
Can a Discretionary Trust work? Yes, if done correctly in advance. For the best chance for this strategy to work ensure that you take advice and plan ahead.
• Maria Posiwnycz is a Director of The Accountancy Firm Limited. Email firstname.lastname@example.org, or call 01902 906 906 or go to www.theaccountancyfirm.co.uk