Trusts are a cornerstone of estate planning and asset management in England and Wales. They allow you to separate the legal ownership of assets from the benefit of those assets, offering a flexible way to control how wealth is managed and passed on. Yet, despite their usefulness, trusts are often misunderstood and can be misused if not set up or managed correctly. Understanding the basics, the different types, and the common pitfalls can help you decide if a trust is right for your circumstances.
What is a Trust?
A trust is a legal relationship created when a person (the settlor) transfers assets to one or more trustees, who then hold and manage those assets for the benefit of one or more beneficiaries. The trust is governed by a trust deed, which sets out the rules and powers of the trustees. The separation of legal and beneficial ownership is what gives trusts their unique flexibility.
Settlor: The person who creates the trust and provides the assets.
Trustees: The people or organisations responsible for managing the trust in line with its terms.
Beneficiaries: Those who benefit from the trust, either by receiving income, capital, or both.
Common Types of Trusts
There are several main types of trusts, each with its own uses and implications:
Bare Trusts:
The simplest form, where beneficiaries have an absolute right to the assets and income. Trustees simply hold the assets until the beneficiary is entitled to them, often used for children until they reach 18.
Interest in Possession Trusts:
Here, a beneficiary (the “life tenant”) has the right to receive income from the trust, but not the capital. The capital usually passes to another beneficiary (the “remainderman”) when the life tenant dies.
Discretionary Trusts:
Trustees have the power to decide how, when, and to whom to distribute income or capital among a group of potential beneficiaries. This flexibility is useful for families with changing needs or where beneficiaries’ circumstances may change.
Will Trusts:
Created by a will and only come into effect on death. These are often used to provide for children or vulnerable adults, or to manage assets for tax efficiency.
Trusts for Vulnerable Beneficiaries:
Special rules apply to trusts set up for people with disabilities or those unable to manage their own affairs, offering potential tax advantages and protection of means-tested benefits.
When to Use Trusts
Trusts can be invaluable in a range of situations:
Protecting young or vulnerable beneficiaries: If you want to ensure assets are managed until a child reaches a certain age, or to provide for someone with a disability without affecting their benefits.
Blended families: Trusts can help ensure children from previous relationships are provided for, while still supporting a current spouse or partner.
Asset protection: Trusts can shield assets from creditors, divorce settlements, or bankruptcy, though courts can sometimes “look through” trusts if they are set up to deliberately avoid obligations.
Tax planning: Certain trusts can help reduce Inheritance Tax (IHT) liability, though anti-avoidance rules are strict and HMRC scrutinises arrangements closely.
Managing business or property interests: Trusts can be used to hold shares in a family business or property, ensuring continuity and control.
Trust Taxation
Trusts are subject to their own tax regimes, which can be more complex than those for individuals:
Income Tax: Trustees may pay tax at the basic or higher rate, depending on the type of trust and the income generated.
Capital Gains Tax (CGT): Trusts have their own annual exemption, but the rates and rules differ from those for individuals.
Inheritance Tax (IHT): Some trusts are subject to “entry,” “periodic,” and “exit” charges, especially discretionary trusts. Bare trusts are usually treated as if the assets belong to the beneficiary for IHT purposes.
A common pitfall is underestimating the tax consequences. For example, transferring assets into a discretionary trust can trigger an immediate IHT charge if the value exceeds the nil-rate band.
Setting Up a Trust
To create a trust, you’ll need a trust deed—a legal document that sets out the terms, powers, and duties of the trustees. Choosing the right trustees is crucial; they must act in the best interests of the beneficiaries and can be held personally liable for mistakes or breaches of trust.
Key steps:
Decide on the type of trust and its purpose.
Choose your trustees carefully—consider appointing at least two, and think about whether a professional trustee is needed.
Draft a clear, detailed trust deed.
Transfer the assets into the trust.
Register the trust with HMRC if required (most trusts now need to be registered on the Trust Registration Service).
Common Ambiguities and Pitfalls
Unclear trust terms: Vague or contradictory instructions can lead to disputes or mismanagement.
Inappropriate trustees: Appointing people who lack the skills or time to manage the trust can cause problems.
Tax surprises: Failing to understand the tax implications can result in unexpected bills.
Failure to register: Most trusts must now be registered with HMRC, even if they don’t generate tax liabilities.
Practical Tips
Review your trust regularly to ensure it still meets your needs and complies with the law.
Keep clear records of all decisions and distributions.
Communicate with beneficiaries to manage expectations and avoid misunderstandings.
Feel less anxious and more confident:
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Disclaimer: This blog post provides general information for educational purposes only. It is not legal advice. Outcomes can vary based on your personal circumstances.
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