The concept of trusts can be a difficult one to explain to non-lawyers. Most people know that they exist but have very little knowledge about how they operate or why they might be established. In recent years they have received a particularly bad rap as they have become associated with unethical tax avoidance although many trusts are established without tax planning in mind at all.
For Private Client solicitors, trusts can be a very useful tool for tax and succession planning. They allow individuals to remove assets from their estates, or to protect those assets for future generations. Trusts can be set up by an individual during their lifetime or after their death, by their Will.
In essence, a trust is a “bubble” into which assets are placed. Trusts do not have a legal personality, and it is the trustees (i.e. the people appointed to manage the trust) who take on legal responsibility for the trust assets. Beneficiaries are the people who can receive a benefit from the trust.
There are a few different types of trusts and I have set out some of the most common forms below. Some companies have created fandangled names for the different types of trusts they can create, however in most cases the trusts will fall into one of 3 categories:
Life Interest Trusts: these are set up to provide an income to an individual (the life tenant) for their lifetime. That person has use of the trust assets and is entitled to income produced by the trust, but they ultimately do not own the assets and cannot dispose of them either under their Will or gift them away during their lifetime. A life interest trust will state who is to receive the assets once the life tenant’s interest has ended. This type of trust is common when couples have children from an earlier marriage or can be used in some cases to mitigate care fees.
Discretionary Trusts: these trusts name multiple, or even classes, of beneficiaries. It is left to the trustees to decide which beneficiary or beneficiaries should receive assets from the trust, and the amounts. No beneficiary is deemed to own the trust assets until the trustees exercise their discretion in that person’s favour. In many cases the trustees will purchase assets for the beneficiary to use or grant loans to the beneficiaries, rather than giving them cash in an outright fashion. This is the most flexible type of trust and allows the settlor (person creating the trust) to provide for people whose needs may not be clear or who they would not want to hand a large sum of cash to (e.g. a disabled beneficiary or a spendthrift). This type of trust is also used to provide for several generations of a family.
Bare Trust: this type of trust states who funds are held for and the amounts they should receive. The trustees do not have any discretion and must hand over the trust fund to the beneficiary, when requested, if the beneficiary is over the age of 18. This type of trust can be set up to manage funds for a minor child and allows those funds to be invested and dealt with for the beneficiary for as long as they wish. They are an especially popular tool for use by grandparents owing to the special income tax treatment of parental trusts for minors.
Each type of trust is treated differently for tax purposes and the tax ramifications of having an ongoing trust can be complex. Because of the potentially complex tax consequences of establishing trusts (particularly during your lifetime) you should always ensure that you take legal advice and understand the process before creating a trust. A good trust solicitor should be able to explain these to you before setting up a trust on your behalf.
A particular word of warning comes if you are advised to set up trusts during your lifetime which seek to move your home outside of your estate for care reasons or inheritance tax reasons. These are often referred to as Asset Protection or Lifetime Asset Trusts. If you continue to live in your home this will almost certainly lead to the value being included in your estate for inheritance tax purposes as a gift with a reservation of benefit. It will also affect the ability for your executors to claim the new residence nil rate band allowance, which can lead to a completely avoidable six figure inheritance tax liability. There may also be capital gains tax consequences as the property may no longer be treated as being occupied by the owner as their home. Moreover, these arrangements may well be caught be the deprivation of asset rules, meaning they may not be effective for the avoidance of care fees. To top it all off, they can be incredibly expensive to set up! If you are considering this course of action, please contact us for further information.
STEP (The Society of Trust and Estate Practitioners) are the gold standard institution for professionals who specialise in work including trusts. You should always check that your adviser is a member; this means that they have completed and been awarded a post graduate diploma in trust and estate planning and have a true specialist interest and expertise in this area of law.
If you are interested in setting up trusts, either now or in your Will, then please contact a member of our Wealth Management Team who would be happy to discuss your situation and determine if trusts are truly the best option for you. Alex Stanier is a full member of STEP and Ashley Minott is an affiliate member (looking forward to her first exam in October!)