Laura Stafford
Solicitor & Head of Private Client
Phone: 0113 200 7480
Email: ls@averywalters.com
Our Private Client Specialist’s Guide to Trusts
We provide a free initial no obligation consultation to discuss trusts, discuss your options, costings, the process and likely timescales.
A trust is the formal transfer of specific assets (such as property, shares, or money) to an individual, trust company, or group of trusted individuals, known as the trustees, instructing that they hold the assets for the benefit of your chosen beneficiaries. The assets placed in the trust are the ‘trust fund’ and the instructions are usually contained in a ‘trust deed’.
Trusts can take effect during lifetime or upon death. There are a number of different types of trust which can be created, depending on how an individual wishes to distribute the benefits of the trust fund.
Why create a trust?
Trusts provide people with a way of protecting their assets and controlling how they are used after they have been given away. The creation of a trust allows the person who is making a gift to attach conditions to it, as opposed to making a lifetime gift or leaving a gift in a Will where the person receiving the gift assumes all rights over the asset and can deal with it as they wish. Trusts are a useful way for families to preserve and manage their wealth for the benefit of their loved ones.
Flexibility – When making an outright gift during your lifetime, it is not possible to change your mind later down the line and give it to someone else. However, with a flexibly drafted trust, it is possible to redirect how the trust fund is benefitted. For example, the income from a rental property may be used by the trustees to benefit a low-income child, but a highly paid child could begin experiencing financial difficulty. Therefore, the trust income could then be redirected to the other child to provide support during their financial difficulty.
Protection – A trust can be used to protect vulnerable or young beneficiaries to ensure that your wealth is not dissipated. For example, a beneficiary may be going through a divorce, and you may be concerned that their spouse will become entitled to the funds left to your chosen beneficiary. A trust is, therefore, an ideal way to protect your beneficiary as the trustees are the legal owners of the assets so this would not fall into your beneficiary’s estate.
Control – When a trust is created, the trust deed sets out how the assets are to be dealt with, who will benefit, and to what extent. The management of the trust assets lies primarily with the trustees, however when a lifetime trust is created, it is common for the settlor to be a trustee. This means that settlors can manage property that they no longer own for the benefit of their beneficiaries, provided that they act in accordance with the trust deed and in the best interests of the beneficiaries.
Trust Types
Trusts typically fall into two main categories depending on how the income or benefit is dealt with (dividends, interest, rents, use of property etc.):
• Interest-in-possession trusts: trusts where the income or benefit must be given to the specific beneficiary – it is theirs’ by right. Although there may be more than one beneficiary, they will all have a fixed entitlement.
• Discretionary trusts: benefits are allocated at the trustee’s discretion to any of the beneficiaries. The trustee’s may decide to benefit no one for a time and accumulate the income for future use.
Interest-in-possession trusts – These trusts are also known as ‘fixed interest’ or ‘life interest’ trusts and are often used in Wills when a person dies leaving a surviving spouse to allow their spouse or civil partner to live on the income. This type of trust is common in the Wills of people marrying for the second time, where each spouse has children to their first marriage. It ensures that the spouse is provided for, but the inheritance of the children from the first marriage is also protected.
Discretionary trusts – Trusts which give the trustees the power to make gifts of capital and/or income to a stated class of potential beneficiaries are known as discretionary trusts. Such trust is useful if you have identified a particular group of people you want to benefit, but are unsure which of them will need help in the future, and in what proportions. For example, grandparents may want to benefit their grandchildren, including those born after they pass away.
Alternatively, you may wish to benefit your children but are aware that some of them are already wealthy and may not require your gift. A discretionary trust in favour of your children and grandchildren would allow the trustees to take into account the changing needs of your children and your grandchildren so that the trustees have flexibility to benefit each when there are appropriate circumstances.
Capital advances and income arising from the trust property are distributed entirely at the trustee’s discretion and no one has an ‘interest-in-possession’.
Discretionary trusts can also be created where the trustees discretion is limited to a certain extent. All the rules of the trust i.e., how the property is to be used, how to share out income, and the powers of the trustees are set out in the trust document. This means that the trust can be tailored to suit your aims.
The most favourable characteristic of a discretionary trust is its flexibility. An English discretionary trust can last up to 125 years and income can be accumulated throughout the lifetime of the trust. The class of beneficiaries can also be enlarged by giving the trustees the power to introduce new beneficiaries as the need arises.
Discretionary Will trusts – Just as discretionary trusts can be created to commence in lifetime, they can also be a feature of a Will, becoming effective only on death.
You may give a portion of your estate to a separate discretionary trust for the benefit of selected individuals. Alternatively, you may prefer that your executors decide how the whole of your estate is to be dealt with in the light of the tax and domestic circumstances existing at the time of your death.
Charitable Will trusts – You may make regular donations to charity or you may have a particular interest in a certain cause. Rather than make regular payments out of income or a legacy to a national charity over which you have no control, you could create your own charity, either in your lifetime or on your death, by creating a charitable trust in your Will. Gifts to such a trust are free of capital gains tax but can only be used for charitable objects.
Vulnerable person trusts – It is possible to set up special trusts for the benefit of disabled beneficiaries. Although these can be discretionary or interest-in-possession trusts, during the lifetime of the disabled beneficiary, special tax rules apply so that it is possible for the trust assets, income and gains to be taxed as if the beneficiary owned them.
What should I look for when choosing a trustee?
In setting up a trust you are giving up ownership of the assets and signing them over to a trustee. The trustee will take responsibility for managing the money or assets that you have set aside in the trust for the benefit of someone else (the beneficiaries). The trustee must use the money or assets in the trust only for the benefit of the beneficiaries and in the best interests of such beneficiaries.
Who can be a trustee?
Anyone over the age of 18 can be a trustee but it is important to consider who you trust with the power and responsibility of trusteeship.
Many people choose to appoint a trusted family member or friend for trusts which take effect after their death. For trusts that take effect in your lifetime, you can appoint yourself and your spouse/civil partner/partner as trustees if you wish. This allows you to retain some control over the assets and the decision-making power, although you must exercise this for the benefit of the beneficiaries.
It is not a requirement to appoint a professional trustee, but it can be helpful if the others are unfamiliar with the obligations of the role. Alternatively, if you appoint your friends or family, they can take advice from a professional trustee when necessary.
Choosing professional trustees
It is important to research before appointing a professional trustee to consider whether you are comfortable with them: -
• Is the Company regulated?
• Do they have a good reputation?
• Do they have professional indemnity cover in place?
• Who are the directors and what are their credentials and background?
• Are their prices reasonable?
Ultimately, the clue is in the name ‘trust’. You must make sure that you trust the person or people you appoint as your trustees.
Trusts and Taxation
Tax consequences may influence the type of trust you choose as an advantage for one tax may create a disadvantage for another.
As a general rule, you, as the settlor, and during your lifetime, your spouse/civil partner, and your minor children must be excluded from all benefit, otherwise the capital will still be regarded as yours for most tax purposes as if you had never created the trust. This rule does not apply if you create a trust in your Will.
Inheritance Tax
Inheritance tax – Trusts created during your lifetime using surplus assets can reduce your own wealth and ultimately, exposure to inheritance tax on your death (as long as you live 7 years after transferring your asses into the trust). There is a charge to inheritance tax when a lifetime trust is created, but at a zero rate of tax if the value is transferred, when added to any gifts within the preceding 7 years, is within the nil-rate band threshold of £325,000. Therefore, there is the opportunity of making tax-free gifts within the nil-rate band over a period of time to reduce your taxable estate on death. If the value transferred exceeds the nil-rate band, then the rate of tax is half that payable on death, i.e., 20%.
Whether a trust is created in lifetime or on death, inheritance tax is applied to the property depending on the type of trust. The majority of lifetime trusts (other than trusts for the disabled and bare trusts) as well as discretionary trusts created by way of a Will are subject to a trust regime which imposes inheritance tax charges when property leaves the trust and on each 10-year anniversary. Currently, the maximum periodic charge will be taxed at 6%.
Interest-in-possession trusts created by Will and trusts for the disabled are subject to a different regime and the beneficiary benefitting from the interest-in-possession is deemed to own the trust assets for inheritance tax purposes only. This means there will be no inheritance tax payable as the asset stays in the trust and remains the interest of the beneficiary, but the trust fund will be taxed at 40% on death, aggregable with the life tenant’s estate.
Capital Gains Tax
Capital gains tax – Capital gains tax is charged on disposals of assets and on gifts, between individuals and when property passes into and out of a trust. Where the gift is to a trust, the tax may be postponed, resulting in a more favourable outcome than an outright gift to an individual. The rate of capital gains tax and annual exemptions are generally less favourable for trusts than for individuals.
Income Tax
Income tax – Discretionary trusts are taxed at a higher rate of income tax, whereas interest-in-possession trusts are taxed at standard rates. The trust rate of income tax is a significant disadvantage where income is to be accumulated. However, there are provisions for the beneficiaries to claim a refund of the additional tax where the income is distributed to them.
Where a settler creates a trust for the benefit of themselves, their spouse or minor children, the income will be taxed as if it belonged to them, regardless of who receives the income. If the settlor and spouse/civil partner are excluded, the settlor may still be taxed if their or their spouse/civil partner’s minor child receives a benefit.
We understand that this process can be daunting due to its complexity. We can advise you throughout the matter, without using legal jargon to ensure you understand everything.
Contact us on 0113 2007480 or email us on info@averywalters.com to arrange your free initial, no obligation consultation with a specialist.
* Laura Stafford is the SFE accredited memberand a full member of STEP