Guide to Trusts

Trusts are an invaluable tool in financial and estate planning, offering flexibility, control, and tax efficiency. Whether you’re planning for your family’s future, protecting assets, or supporting a cause close to your heart, understanding trusts can help you achieve your goals.

In this guide, we’ll break down what a trust is, the different types available in the UK, and their benefits.

What Is a Trust?

A trust is a legal arrangement where one party (the settlor) transfers assets to another party (the trustee) to hold and manage for the benefit of a third party (the beneficiary). These assets can include money, property, shares, or other investments.

Trusts can be used for various purposes, such as:

• Safeguarding wealth for future generations.
• Reducing inheritance tax (IHT) liability.
• Ensuring financial support for loved ones.
• Protecting vulnerable beneficiaries.

Types of Trusts in the UK

1. Bare Trusts

How it works: Assets are held in the name of the trustee, but the beneficiary has an absolute right to the assets. Once the beneficiary reaches the age of 18 (or 16 in Scotland), they can take full control of the trust assets.

Common uses: Often used for gifting money or assets to children under 18, providing a straightforward way to pass on wealth without immediate tax consequences.

2. Discretionary Trusts

How it works: Trustees have full discretion over how and when to distribute the trust’s income or capital to beneficiaries. The settlor can provide guidance through a “letter of wishes”, but this is not legally binding.

Common uses: Useful for families wanting flexibility, especially where beneficiaries have varying needs or there is a risk of financial irresponsibility. Discretionary trusts are also ideal for preserving assets in complex family situations, such as blended families or protecting against potential claims from creditors or divorces.

3. Interest in Possession Trusts

How it works: The beneficiary is entitled to the income generated by the trust assets but not the assets themselves. The trust capital remains protected for future beneficiaries, often referred to as “remaindermen”.

Common uses: Frequently used in wills to provide income for a surviving spouse while ensuring the capital eventually passes to children or other designated beneficiaries. This is particularly valuable in second marriages to ensure children from the first marriage are not excluded from inheritance.

4. Trusts for Vulnerable Beneficiaries

How it works: Designed for beneficiaries who are disabled or vulnerable, with special tax rules that reduce the burden of income tax and capital gains tax on the trust.

Common uses: Protecting the financial future of individuals who cannot manage assets independently due to physical or mental disabilities. These trusts can ensure that beneficiaries receive financial support without affecting their entitlement to means-tested state benefits.

5. Charitable Trusts

• How it works: Assets are set aside to benefit a registered charity or multiple charities. Trustees ensure the assets are used in accordance with the charitable purposes outlined by the settlor.
• Common uses: Supporting charitable causes while benefiting from significant tax reliefs. Charitable trusts can be an excellent way to leave a lasting legacy, supporting causes you care about long after your lifetime.

6. Settlor-Interested Trusts

How it works: The settlor can benefit from the trust, either directly or indirectly, while also acting as a trustee.

Common uses: Often established for practical reasons, such as managing property, but come with complex tax implications. Professional advice is essential when setting up this type of trust.

7. Life Interest Trusts

How it works: A specific type of interest in possession trust where a beneficiary, often a spouse, has the right to live in a property or receive income from it for their lifetime.

Common uses: Commonly used in wills to allow a spouse to remain in the family home while preserving the property’s value for children or other beneficiaries after the spouse’s death.

8. Mixed Trusts

How it works: Combines elements of different trust types, such as discretionary and interest in possession trusts, to meet complex needs.

Common uses: Often used in high-net-worth estate planning where multiple objectives, such as income provision and tax efficiency, need to be balanced.

Key Benefits of Setting Up a Trust

1. Tax Efficiency
   • Certain trusts, such as charitable and vulnerable beneficiary trusts, can significantly reduce inheritance tax (IHT) and capital gains tax (CGT) liabilities. For example, assets placed into a discretionary trust can grow outside of your estate, helping to minimise future IHT.
2. Asset Protection
   • Trusts shield assets from creditors, divorce settlements, or financial mismanagement by beneficiaries. This is particularly important for business owners or individuals with complex family structures.
3. Control Over Distribution
   • Trusts allow you to set specific terms and conditions for how and when beneficiaries access the assets. For example, you can set up milestone distributions, such as releasing funds when a beneficiary reaches a certain age or achieves specific life goals.
4. Support for Vulnerable Beneficiaries
   • Vulnerable beneficiary trusts ensure that individuals who cannot manage assets independently are supported without losing eligibility for state benefits. Trustees can use their discretion to meet the beneficiary’s needs while preserving the trust capital.
5. Privacy
   • Unlike wills, which become public documents after probate, trusts provide a confidential way to manage and distribute assets. This is particularly valuable for high-net-worth individuals who want to keep their financial affairs private.
6. Preservation of Wealth
   • Trusts help ensure that assets are preserved for future generations, especially in families with substantial wealth. They can protect against scenarios such as overspending or mismanagement by beneficiaries.
7. Charitable Impact
   • Charitable trusts allow you to make a significant and lasting impact on causes you care about while benefiting from tax relief. This can be a powerful way to align your financial legacy with your values.
8. Flexibility
   • Mixed trusts and discretionary trusts offer flexibility to adapt to changing circumstances, such as new tax laws or shifts in family dynamics.

Tax Implications of Trusts

Trusts can have complex tax rules, so professional advice is essential. Key taxes to consider include:

• Inheritance Tax (IHT): Transfers into certain trusts, such as discretionary trusts, may attract an immediate 20% tax charge if they exceed the nil-rate band (currently £325,000 per individual). However, once assets are within the trust, their growth is generally outside the settlor’s estate.
• Income Tax: Trustees pay income tax on trust income at higher rates for most trusts, currently 45% on non-dividend income and 39.35% on dividend income. Beneficiaries may reclaim overpaid tax depending on their personal tax situation.
• Capital Gains Tax (CGT): Trustees may be liable for CGT on gains made when disposing of trust assets. However, trusts benefit from a lower annual CGT exemption than individuals (£3,000 for 2024/25).

Special rules apply to certain types of trusts, such as vulnerable beneficiary trusts, which can offer more favourable tax treatment.

How to Set Up a Trust

1. Define Your Objectives
   • Determine why you need trust and what you want it to achieve. For example, are you looking to protect assets for your children, support a charitable cause, or provide for a vulnerable relative?
2. Choose the Right Type of Trust
   • Select the trust that aligns with your goals and the needs of your beneficiaries. Consider the long-term implications of each type, including tax efficiency and administrative responsibilities.
3. Appoint Trustees
   • Choose trustworthy and capable individuals or a professional trustee service to manage the trust. Trustees should understand their legal and fiduciary duties, as they will be responsible for managing the trust’s assets and acting in the best interests of the beneficiaries.
4. Draft a Trust Deed
   • Work with a solicitor to create a legally binding document outlining the trust’s terms. The deed should specify the trust’s objectives, the beneficiaries, the trustee’s powers, and any conditions for distributions.
5. Transfer Assets
   • Move the chosen assets into the trust to make it operational. This process may involve legal formalities, such as transferring property deeds or registering investments in the name of the trust.
6. Maintain the Trust
   • Trustees must keep accurate records, file annual tax returns, and review the trust’s performance regularly. Ongoing professional advice can help ensure the trust remains compliant with legal obligations and continues to meet the needs of the beneficiaries over time.

Conclusion

Trusts are powerful and versatile tools that can help you achieve a wide range of financial and estate planning objectives. Whether you are looking to protect your assets, provide for loved ones, support charitable causes, or reduce tax liabilities, there is likely a trust that suits your needs.

Setting up a trust requires careful planning and expert advice to navigate the complex legal and tax implications. By understanding the types of trusts available and their benefits, you can make informed decisions that safeguard your wealth and legacy for generations to come.

If you’re considering setting up a trust or want to explore how trusts could fit into your financial plan, get in touch with us to discuss your options.