Trusts - "asset protection" on bankruptcy?

15 May 2020

Let’s cut straight to the chase - despite the assurances of the man in the pub and the claims of some dubious “estate planning” outfits, you cannot effectively put your own assets beyond the reach of creditors on bankruptcy by wrapping them in a trust.
 

Back to basics. A trust is created by giving control of assets to third parties (“Trustees”) for the benefit of others (“Beneficiaries”). The motive may be to provide benefits across successive generations of the family or as a means of protecting beneficiaries from themselves or from the inappropriate attentions of others.

A parent, concerned at a child’s spendthrift ways or the company they keep, might consider it irresponsible and risky to give or leave that child substantial wealth outright. So they might make the gift or legacy in the form of a trust, whereby the child is only entitled to the income produced and not the capital (a “Life Interest Trust”) or entitled to nothing at all unless the trustees decide to distribute  income or capital from the Trust Fund to the child     ( a “Discretionary Trust”).

If the (adult) child goes bankrupt, then the capital within the Trust Fund is safe from the legitimate demands of the child’s trustee in bankruptcy. If it’s a life interest trust, then the income to which the child is entitled as of right should nevertheless be paid to their trustee in bankruptcy until the child is discharged from the bankruptcy.  If it is a discretionary trust, then any payments to the child the trustees choose to make similarly need to be declared by the child and handed to the trustee in bankruptcy insofar as they exceed what’s reasonably needed for maintenance.

Can you transfer assets into a trust to ring fence them against the demands of your own creditors should you, personally, be made bankrupt?

The short answer is “no” with the double whammy of such transfer into trust likely landing you with some, potentially very nasty, tax consequences.

English law has long since taken issue with attempts to offload assets to keep them out of the pot properly available to creditors on bankruptcy. The current law is contained in the Insolvency Act 1986.

Any gifts (either outright or into a trust) will be set aside by the Court (and the property given brought back into the bankrupt “estate”) if they are:

  • Made within the 2 years before the date of the bankruptcy application;
  • Made within 5 years of the application if you were insolvent at the time ( or became insolvent as a result of making the gift ); or
  • Made at any time if the Court is satisfied that the gift was made with the purpose of putting the assets given beyond the reach of existing or future creditors.

For gifts (outright or into trust) falling outside the specified 5year/2 year periods, the key will be the “purpose” of the gift.

If, when wealthy, I make a gift to my children to mitigate inheritance tax on my death, that gift, made for a clear and rational purpose, might not be questioned when, some years later, my previously successful business fails and I’m made bankrupt.

Problem gifts are those where no sensible and believable reason can be established other than an attempt to put assets beyond the reach of creditors. While “inheritance tax planning” may be the principal reason for making substantial lifetime gifts, that argument won’t wash if:

  • Your estate is within the available nil rate bands so there’s likely no liability to Inheritance Tax on your death; or
  • You continue to enjoy the assets given away so there remains a charge to tax on death by reason of the “Reservation of Benefit “ rules or, alternatively, a charge, now,  to Pre-Owned Asset Tax.

Remember also:

  • If  a gift of assets  is made ( as opposed to cash), there may be a substantial charge to Capital Gains Tax
  • The gain can be “held over” if the gift is into trust, though there is lifetime inheritance tax at 20% if more than £325,000 is given, tenth anniversary charges (max 6%) and a reservation of benefit issue if you’re a beneficiary of the trust or otherwise enjoy the assets in any way

Incurring tax in an unlikely unsuccessful attempt to put assets beyond the reach of potential creditors does not make sense.

My oft-repeated advice “Don’t give away the family home!” makes yet another appearance here. Where the family home is an individual’s principal asset, there could be fear that it may need to be sold to meet a future liability – to contribute to nursing home fees for example.

The (adverse) Capital Gains Tax and inheritance tax (likely no advantage) implications of “putting the children’s name on the deeds”, as well as the inherent risks of your children selling your home from under you (either intentionally or by reason of death or divorce) mean there can rarely exist a motive other than an attempt to avoid, say, the liability to contribute to nursing home fees. Being persuaded to create some sort of “Asset Protection Trust” on the purported pretext of “avoiding the probate process” seems unlikely to wash.

The upshot is that the full value of the family home will likely continue to be treated as “notional capital” in working out the contribution to nursing home fees even after other resources have dwindled to nothing. Making an elderly person bankrupt and having the gift of the home set aside to be sold so that care fees can be recouped is not uncommon.

Other principal potential claim on our assets - divorce

The possibility of our divorcing is something that worries our parents as much as, if not more so, than it worries us. The suggestion of a pre-nuptial agreement often stems from the wealthy parent of a party to the marriage rather than the loved-up couple themselves. Parents may harbour a strong desire to pass their wealth to their children, but would be loath to see it disappear to a son-or-daughter-in law on divorce. For the treatment on divorce of both outright gifts made and family trusts created by a parent/relative of one party to a marriage, I defer to the excellent blog written by my colleague  in our Family Law team, Abby Buckland - Ways of protecting family wealth on divorce.

Further Information

If you have any questions about the issues covered in this blog, including trusts, asset protection and estate planning, please contact a member of our private client team.

About the author

Jim Sawer is a partner in our private client team. He has a broad private client practice and has advised families in the UK and overseas, including those with commercial and landed interests, for over 30 years.  Clients appreciate his ability to identify the true crux of a matter promptly and his results-orientated approach to resolving private client issues in the family context.

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