Whither A&M Settlements?
Before the Finance Act (“FA”) 2006, an Accumulation and Maintenance (“A&M”) settlement was broadly speaking treated as exempt from IHT until the beneficiary reached the age of 25. If the assets remained held in trust after that time the settlement was converted to a life interest trust and generally speaking IHT then became payable on, but not before, the death of the life tenant.
In general terms, the effect of FA 2006 is to bring A&M settlements, at the end of a transitional period (6 April 2008), into the very different IHT charging regime which to date has applied only to discretionary settlements. Under this regime – called “the relevant property (“RP”) Regime”–
- The trust capital is subject to IHT every ten years: the periodic charge. The rate is calculated according to a tortuous formula but at present the top rate would be 6%;
- If trust capital is paid or transferred out of a Settlement there is an IHT “exit” charge. The rate-formula can be even more complex than with the periodic charge but the general effect is that “exits” are charged at a rate which is a proportion of the rate payable on the last ten-yearly periodic charge.
A&M Trustees can simply allow their settlement to enter the RP Regime on 6th April 2008. There may be good reasons for doing this. FA 2006 does however offer two alternatives. Trustees do not need to take the same decision in relation to the whole settlement. They could take different decisions in relation to the different beneficiaries’ shares. The two alternatives to entering the RP Regime on 6 April 2008 are:
Age-18 entitlement: The Trustees could modify the settlement (or beneficiary’s share) before 6th April 2008 so that the beneficiary becomes entitled to the capital outright at 18. In this event the trust fund will, until the beneficiary reaches 18, continue to enjoy the attractive pre-FA 2006 IHT regime applicable to A&M settlements: no periodic charge and no charges on “exits”. If any beneficiary is already over 18 this means ending the trust of his share before 6 April 2008 and advancing the capital out to him.
Age-25 entitlement: The Trustees could modify the settlement (or share) so that the beneficiary becomes entitled to the capital outright at 25. In this event:
(i) The trust fund is kept out of the RP Regime whilst the beneficiary is under 25. Thus if a ten-yearly anniversary occurs during this period no periodic charge will arise.
(ii) However, once the beneficiary reaches 18 (or from 6th April 2008 if he is already over 18) a special IHT charge accrues and will be payable when the beneficiary reaches 25 (or is given his share outright before then). Again, the rate-formula is complicated. Top rate at 25 would be 4.2%.
Trustees can be forgiven if they feel bewildered by the complexity of the issues now facing them and on which they will need to make a decision some time over the course of the next 12 months, even if it is to do nothing. Charting a path through the legislative labyrinth is well-nigh impossible without sound professional advice. Here are a few key points together with some broad conclusions that we have drawn from our experience to date:
- Before considering either of the two alternatives Trustees should check whether they have sufficient powers under the terms of their settlement to make the necessary modifications. In the case of old A&M settlements this may not be the case and in that event an application to the Court for the necessary powers would be required.
- Trustees should check and diarise the date when each beneficiary takes an entitlement to income. This could occur before 6 April 2008 i.e. through the operation of s.31 Trustee Act 1925. The point is that the Age-25 alternative cannot be adopted in respect of a beneficiary who has become entitled to income.|
- Despite the condition in the alternatives as to entitlement at 18, or 25, Trustees may in fact have powers which they could exercise to prolong the trust of a beneficiary’s share beyond the specified age. The share would enter the RP Regime at that point.
- If the Age-25 alternative is chosen the shares for the beneficiaries in both capital and income have to be fixed now. For this reason the Age-18 alternative is often more attractive where the settlement has very young beneficiaries and it is felt desirable to retain flexibility on how income and capital is distributed until they reach 18. Moreover if the Age-25 alternative is chosen it seems that future-born beneficiaries are excluded.
- The much-quoted top rate of 6% for the periodic charge for related property is misleading. Usually the rate will be less than 6%. On the first ten-yearly periodic charge after 6th April 2008 the rate will never be 6%. The top rate of 4.2% for the special IHT charge at 25 under the Age-25 alternative is similarly misleading. It will usually be less.
- If the prospective IHT charges are of paramount concern there is no substitute for wrestling with the rate-formulae and applying them to the circumstances of the settlement. The results can be unexpected and sometimes are surprisingly beneficial, especially in the calculation of the special IHT charge payable under the Age-25 alternative when the beneficiary reaches 25.
- The attractions of doing nothing and allowing a settlement to enter the RP Regime on 6th April 2008 may be increased if the settlement was set up in, say, 1987 or 1997 and holds valuable real property where it is not desirable for any beneficiary to take capital. No IHT charge will arise until the first periodic charge in 2017 and the view might be taken that by then the legislation may well have changed again!
- Many Trustees of large settlements are inclined to do nothing, especially in cases where a significant proportion of the trust assets qualifies for 100% agricultural or business property relief and is therefore effectively exempt from IHT anyway.
- One of the unfortunate consequences of the FA 2006 charges is that CGT complications now arise in settlements of land if beneficiaries are allowed to become entitled to capital at different times e.g. as each beneficiary reaches the age of 18 or 25.
- Funding the IHT payments can be the major problem where the trust assets are mainly illiquid e.g. shares in private investment companies or farmland with only 50% APR. One solution can be to convert the over-25 beneficiaries’ shares from life interest trusts to discretionary trusts so as to allow any income that arises to be capitalised to meet future IHT payments. Most modern A&M settlements give the Trustees sufficient powers to do this and a beneficial side effect of the FA 2006 changes is that such an alteration in the trusts of an over-25’s share is now IHT-neutral.
In the next issue of the e-alert we shall look at the other types of settlement affected by the Finance Act 2006 changes: life interest settlements.