Trusts are becoming a mainstream planning tool to help protect wealth but can be difficult to understand. There are many reasons why you might use a trust and lots of types to choose from. Here we look at what a trust is, why you might create one and explain the different types to consider.
What is a Trust?
A trust is the formal transfer of assets to a small group of people known as Trustees to hold and safeguard for the benefit of others. There are three main parties involved within a trust: a settlor, the person who establishes the trust. A trustee, the person entrusted to hold the assets for the beneficiaries and the beneficiary, the person entitled to benefit from the trust.
Why create a Trust?
Trusts are created for a few reasons. Tax planning is a common driver by facilitating the gifting of an asset, other reasons include control, protection and flexibility.
When transferring assets into Trust, the trust deed (or will) can set out who will benefit and in what proportion. In addition, if it is a lifetime trust, it is possible for a settlor to retain some control over the trust assets by appointing himself as a trustee which is not possible with an outright gift.
If you feel that an outright gift may not be spent in a sensible way, it is possible to hold money in a trust for a specified purpose, for example university fees. This enables the gift to be made for the benefit of the person without them having the ability to spend the money on something more frivolous.
Depending on the terms of the Trust, it may be possible to alter the beneficiaries depending on the need.
Note: For a trust to be effective for many of the tax advantages, it is important to give up any right to the asset transferred.
Who is the settlor of a Trust?
A settlor is the person who establishes the Trust. They do this by a transfer of assets. The transfer can be done during a lifetime through a deed, or on death via the will.
Who is a Trustee?
A trustee is a person who is entrusted to hold the assets for the beneficiaries. For practical reasons, there is usually more than one. They are the legal owner of assets and are appointed to administer the Trust for the benefit of third parties – known as beneficiaries.
Who can be a Trustee?
Anyone over the age of 18 can be a Trustee providing they have mental capacity. A Trustee has a statutory duty of care towards beneficiaries and must exercise reasonable care and skill. A trustee could be; the person making the gift – the settlor, a professional e.g. solicitor, family members or close family friends.
A professional such as a solicitor or accountant acting as a trustee will have a greater duty of care by virtue of their enhanced knowledge and expertise. It is unusual for a trustee to act alone due to complications that can arise should the appointed trustee become incapacitated or die. More commonly two or three Trustees will act together.
What is a Beneficiary?
A Beneficiary is the person entitled to benefit from the trust. There may be more than one beneficiary.
Types of Trust
There are many different types of trust. They can be used in a number of different ways and have both advantages and disadvantages.
A Discretionary Trust is extremely useful if you are not entirely sure how you would like to distribute your estate. It gives the trustees the discretion to decide who should benefit and in what proportion, no-one has the right to either income or capital. A letter of wishes may be drafted to guide the trustees as to who should benefit.
This allows flexibility in situations whereby perhaps the children or grandchildren may not yet be born at the time the Trust has been setup. These trusts are within the relevant property regime which means they are subject to inheritance tax. Any gifts into such a Trust will be chargeable lifetime transfers unless covered by an exemption.
This might suit someone who wishes to make regular donations to charity or a one-off significant donation towards a particular cause. By creating a Charitable Trust, you can make sure the causes you believe in can benefit in the way in which you want. Gifts to Charitable Trusts are free of any inheritance tax and capital gains tax and may also qualify for income tax relief. The income arising in the trust will not normally be subject to income tax although proper records and accounts do have to be kept.
A Bare Trust, also known as an Absolute Trust is a modest agreement where the beneficiary has an absolute right to both the income and the capital. They are most often used for minor children who do not have the capacity to take legal title themselves. Where the beneficiary is an adult, the trustee position is more like a nominee and they must follow the directions of the beneficiary in relation to assets held.
A trust for a vulnerable person can be either discretionary or interest in possession. During the lifetime of the disabled beneficiary beneficial tax rules can apply treating the assets, income and gains as through they belong to the beneficiary and taxed accordingly.
Note: HMRC have parental settlement rules so where a Trust is set up by a parent for their minor child(ren), income tax will continue to be assessed against the parent/s where this exceeds £100 pa (£200 pa if a joint gift)
Benefits of a Trust
The main benefits are centred around a mixture of control, protection and flexibility. Inheritance tax planning is also a common benefit of using a trust, but it's important to note that an outright gift to an individual would achieve the same inheritance tax advantages.
Drawbacks of using a Trust
It is important to be aware of the additional complexities in respect to Trustees’ duties, including being aware of the taxation applied to different types of Trust. It can be extremely challenging to decide if a Trust is the best solution for you and which Trust is most suitable for your individual requirements.
How can we help?
The Private Office has a wealth of experience advising trustees on their investments and working with them to ensure they are fulfilling their duties. As well as providing financial planning advice and asset management services for our Trust clients, we can also provide an independent view of portfolio performance when benchmarked against market averages.
If you would like to find out more about whether trusts are the right solution for you, get in touch to arrange a consultation.