Rob Noble Warren of Independence Financial Planners, says that small discretionary trusts do not always achieve the goals they were set up for
It was that period between Christmas and New Year when people were walking around Sloane Square without their usual pre-occupation, more free than usual to look around. At the top of Peter Jones, there is a restaurant overlooking London's roof tops, and it was there that my client, her brother and nephew met for an informal lunch.
Mrs Wagner was 65, sprightly, and toughened by circumstance. As a Jew she had been moved to Poland, then to South Africa and then to England, fortune and calamity falling into her life with abandon. "I am thinking about helping the children," Mrs Wagner said "but I am worried that I might need all my money."
She is a beneficiary of a UK-based discretionary trust of about £250,000, her brother is a trustee, and all the next generation were also potential beneficiaries.
Working with trusts
There is a problem with small discretionary trusts. Not that they are tax-inefficient, because they do save on inheritance tax (IHT); and not that they are expensive to run; but that there is no proof that they actually achieve the human result they were intended for. This one was supposed to be a safety net for Mrs Wagner and to improve the lot of her family. Eileen Gallo - a psychologist specialising in wealth management - has written that people who inherit money without the knowledge of how to deal with it regard the whole exercise as worse than useless. Earlier research categorised an inheritance as 'worse than having a road accident'. In our practice, we believe that simply dumping money onto the next generation is not useful without education.
We thought there was one more requirement too - the willingness to work together. In another family, one spouse had died leaving a standard nil rate band discretionary trust in favour of the other spouse and children. The surviving spouse was marginally comfortable, but vulnerable to needing long-term care. The family responded by freezing any activity on the trust's investments while they pondered whether the money would have to be used for the father during his life, or whether they could wait for his death and then wind up the trust. In the meantime, one son's business was collapsing and one daughter's marriage was breaking down.
Instead of working together to understand each other's needs, this family simply froze the assets out of their considerations, failing to recognize that the £50,000 or so saved in IHT was not as valuable as having the right support at the right time. Francis Fukuyama, an economist from the George Mason University in Washington DC, has described this willingness to work together as "social capital": and that this factor alone could explain the GDP super-growth of Korea and Singapore.
These three - intellectual capital, social capital and financial capital - need to work together for any small family discretionary trust to achieve its purpose. In particular, we have come to regard the common IHT nil rate band trust as a family's answer to the unraveling of the State safety net.
Look at all the options
"Mrs. Wagner," I began, "I am not here today as part of a beauty parade, to win your business. I am going to treat you as family, if I may. In fact I am going to tell you the alternatives which I think could achieve your objectives. But you know your family better than I do, so you make the final decision.
"This money is now on deposit, earning 3.8% less tax. That is not so bad. Your brother is meant to be handling the investment strategy of the trust but does not know what he should be aiming for. Your nephew tells me that he does not want any money but his sister is in trouble with her marriage and her health. You are telling me that if you are forced to start again, the trust needs to be able to buy you a home, in England. But you also want to help the next generation of your family.
"One way you could achieve your objective is to leave the money on deposit, and regard it as your personal reserve. When you die, your family will ask the trustees to distribute the capital, and they probably will. This is only marginally effective.
"Another way is that you could invest for growth now, in the belief that you will not need this money, and you want to maximise your family's inheritance. This option too is unlikely to be viewed as anything more than slightly helpful by the recipients, partly because you are likely to live so long.
Pool your resources
"Another way is to buy a property now that you would be happy to live in if you had to, and rent it out. Talk to your family and find out which of them are willing to help. Think of it as a family council: their job is to be aware of family needs so they can advise the trustees on where the limited resource of the trust can do most good.
"Perhaps there is an accountant among them who can help with the trust accounts or perhaps there is a tax specialist who can check out the changing law in the area of pre-owned assets.Take your time. Then let the trust make distributions to the family members in need from the rental income. That should be £7,000 every year after tax. Working together in this way will affect the dynamics and confidence of the family in the next 30 years. Sometimes, they will be just greedy: sometimes, they will surprise you. But you may come to believe this is the most effective way for the trust to achieve its obligations.
"In the meantime, I suggest you take a year to talk to everybody in the family, and make your own mind up how they are feeling about their future, and whether they believe they are going to have a tougher time of it than even you had. Just listen. Let us have lunch again, same place, same time, next year and let us all know which of the three alternatives above you think would do most good."
Rob Noble Warren is a chartered tax advisor and certified financial planner. He works for Independence Financial Planners, who comment for the Financial Times Money Makeover. He is also a regular columnist for Bloomberg Money.
Intellectual, social and financial capital need to work together for any small family discretionary trust to achieve its purpose.
Talk to your family, find out who is willing to help. Advise the trustees where the resources can do the most good.
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