Understanding Trusts – An Introduction

The term flexible trust was originally associated with the use of a type of trust known as a discretionary trust.

Trusts have been used inside of Wills for many, many years. The rules changed in March 2006 and the use of the ‘2 year' discretionary trust has opened significant doors for planning powerful and ‘flexible' Wills.

A trust is one of the few devices recognised within the legal system that provides a mechanism to allow the concept of ‘Own Nothing Control Everything' (ONCE – did you see what we did there?) to be explored and utilised to its core.

Frequently Asked Questions

What is a trust?
A trust is a legal arrangement created in life or through a will. The “settlor” places assets in the trust, which are then managed by a third party, known as the “trustee”. The trustee holds legal title to these assets for another person or people, referred to as the “beneficiary” or “beneficiaries”. Trusts are established for various reasons, including wealth management and preservation, protection of assets, provision for loved ones, or tax planning.

How does a trust work?
Trusts are governed by a variety of laws and regulations. The settlor transfers legal ownership of certain assets to the trustees, who then manage these assets on behalf of the beneficiaries. The trustees have a fiduciary duty to act in the best interests of the beneficiaries, following the terms of the trust deed. They can make decisions about how the assets should be used – for example, how the income generated from the assets should be distributed.

What are the different types of trusts?
There are several types of trusts, each serving different purposes. Bare Trusts are simple structures where the beneficiary has the right to both income and capital. Interest in Possession Trusts give the beneficiary entitlement to trust income but not necessarily the capital. Discretionary Trusts allow trustees to make decisions about how to use the income and capital. Accumulation Trusts allow trustees to accumulate income and add it to capital. Settlor-interested trusts are where the settlor or their spouse benefits from the trust. Mixed Trusts combine elements of different types of trusts.

How is a trust taxed?
Trust taxation can be complex. Trusts are subject to Income Tax on income they receive, Capital Gains Tax on profits made from selling assets, and Inheritance Tax in certain circumstances. The tax rates and reliefs vary depending on the type of trust and the relation between the settlor, trustees, and beneficiaries.

Can a trust protect assets from inheritance tax?
Some trusts can help mitigate the impact of Inheritance Tax. For example, trusts can be used to pass wealth to future generations while reducing the potential Inheritance Tax payable. However, the rules are intricate, and trusts may be subject to ‘ten-yearly charges' or ‘exit charges'. Professional advice is crucial when using trusts for Inheritance Tax planning.

How to set up a trust?
Setting up a trust usually requires legal assistance. It involves choosing the type of trust that best suits your needs, appointing trustworthy trustees, defining the terms of the trust deed, and transferring assets into the trust. The process can be complex and requires careful planning to ensure the trust operates as intended and complies with all relevant laws and regulations.

What are the duties of a trustee?
Trustees have significant responsibilities. They must manage the trust's assets in the best interests of the beneficiaries, following the trust's terms and the law. Duties include managing investments, keeping records, preparing accounts, and paying any taxes due. Trustees can be held personally liable for breaches of trust.

What is a discretionary trust?
A discretionary trust gives the trustees the power to decide how the trust's income, and sometimes the capital, should be distributed among the potential beneficiaries. This flexibility allows trustees to consider the beneficiaries' circumstances at the time of distribution, rather than predetermining who benefits at the outset.

Can you change the terms of a trust?
It may be possible to change the terms of a trust, depending on the type of trust, its terms, and whether all beneficiaries agree. Changes could include altering beneficiaries, changing trustees, or modifying the trust's terms. Changing a trust’s terms can be legally complex, so professional advice is usually necessary.

What happens to a trust when the settlor dies?
When the settlor dies, the trust typically continues to operate according to the terms set out in the trust deed. The trustees will continue to manage the trust's assets for the benefit of the beneficiaries. However, if the trust was written into the settlor's will, it will come into effect upon their death.

What Can You Put Into A Trust?

Essentially, You Can Put Anything You Want Into A Trust. However, there is a caveat to this. You have to be the full owner of the asset. That means you must have the full rights, title and interest to the asset. The one who creates a trust or ‘settles' property into a trust is known as the settlor. The asset must be unique and specific. So it must be easily identifiable. Saying “I put this Ten Pound Note into a trust” is not good enough. How can one ten pound note be differentiated from another? So these are known as fungible assets. They're not really a good mix when it comes to creating trusts.

What is the Purpose or Intention? Even though it is possible to put anything into trust, there are a few more elements that should be considered. Firstly, what is the purpose of creating the trust, this is really, really important. Intent is everything in the world of trusts, and if the intent is not positive, there will be issues.

Who or What Are The Objects of the Trust? The “objects” of a trust are its beneficiaries, who can be individuals, groups, or organizations. They have the right to benefit from the trust's assets. The settlor, who creates the trust, defines these objects in the trust deed. They can be specific persons, like family members, or broader categories (e.g., “my grandchildren”). Sometimes, the objects can be charitable organizations, creating a charitable trust. Clearly defining the trust's objects is crucial for its validity.

As you are probably realising, trusts are really simple but probably not really easy to get your head around. It's not a ‘regular' way of thinking for most people so the rules take a little getting used to. However, once fully understood, it will really hold you and your family in good stead.

Utilising Experts for Advice is essential! Indeed, if you are serious about trusts and their use, seeking advice from a specialist, not a generalist, is crucial. We at ONCE Wills and Trusts are not just specialists, but experts dedicated to providing you with accurate, personalized trust advice. Our team has the knowledge and experience to guide you through the complexities of setting up and managing a trust. We believe in empowering our clients with the right information, ensuring their assets are protected and their future secure. Let us assist you in this important aspect of financial planning.

Understanding trusts and taxes

What Are The Different Types of Trusts?

There are two main types of trusts. An Absolute Trust and Discretionary Trust. There is also a special type of trust, what we like to call a hybrid or the best of both worlds trust, known in the legal world as an Interest In Possession trust or IPDI for short.

To keep things super simple. An Absolute Trust is one where the trust is literally just holing onto the asset on behalf of the beneficiary, however the beneficiary calls all the shots and are in control. Not much different to an individual holding onto their own asset. Therefore it's not ‘really' seen as a trust at all, however they are still very powerful if used for the purpose intended. Normally used for Minor children (under 18) who are deemed not yet eligible to start calling the shot according to the law.

A Discretionary Trust is totally opposite to an absolute trust. The Trustees have 100% discretion and autonomy over the asset. They have full fiduciary duty towards the beneficiary and their powers are conferred to them by the Settlor the creator of the trust. The Beneficiary does NOT have an automatic right to enjoy the property unless the Trustees ‘appoint' them. And this is what makes such a trust extremely powerful. The asset does not belong to the beneficiary, it belongs to the trust!

Here's where it gets interesting… An Interest In Possession Trust (IPDI) has the best of both worlds. The trustees have a say with regards to the capital (normally the underlying asset such as the bricks and mortar and land title to a house or the use of a car but not the ownership of the car itself). The Beneficiary, has absolute authority to enjoy the fruit or benefit of the asset, what is known as income. So you can live in the house, play music, use the shower, but you can't just decide to sell it or give it away as it's not yours. Again, this type of trust is very powerful if used for the purpose it was intended.

Tax, each type of trust has a complete different tax treatment and so this is where things get real complicated and hence why you should consider speaking to a specialist (we are specialist) and not a generalist in this area.

What Are The Key Benefits Of Having A Trust?

Asset Protection Trusts can act as a powerful tool for protecting your assets. They can shield your estate from creditors, lawsuits, and other potential threats. This is particularly beneficial if you own a business or have substantial wealth. By placing assets in a trust, you ensure they are managed according to your wishes and are preserved for future generations.

Estate Planning and Avoiding Probate One of the main reasons people set up trusts is to avoid the probate process. Probate can be time-consuming, expensive, and public. With a trust, assets can be passed directly to the designated beneficiaries without going through probate, saving time and maintaining privacy. This can spare your loved ones from added stress during an already difficult time.

Tax Efficiency Trusts can also provide significant tax advantages. For instance, an AB trust can help minimize estate taxes, allowing more of your wealth to pass on to your beneficiaries. Additionally, certain types of trusts can provide income tax benefits or allow you to reduce or avoid capital gains tax.

Control Over Asset Distribution Trusts offer a level of control over your assets that other estate planning tools do not. You can specify exactly how, when, and to whom your assets should be distributed. This is particularly useful if your beneficiaries are minors, have special needs, or might not use the assets wisely. You can even set conditions for distribution, such as completion of a college degree or reaching a certain age.

Special Needs Planning For families with special needs individuals, trusts can be an invaluable tool. A special needs trust can provide for a disabled loved one without affecting their eligibility for government benefits like Social Security or Medicaid. This ensures they have access to the additional resources they need without losing essential benefits.

In conclusion, setting up a trust can offer numerous benefits, from asset protection and tax efficiency to control over asset distribution and special needs planning. It's advisable to consult with a legal or financial advisor to understand which type of trust is most suitable for your specific situation.

Bare trusts, also referred to as simple or absolute trusts, are the most basic form of trusts in UK law. The trustee holds the assets but they legally belong to the beneficiary. The trustee has no discretionary powers, meaning they must act upon the beneficiary's instructions in relation to the trust's assets. Bare trusts are particularly useful for transferring assets to minors, where the trustee would hold onto the assets until the beneficiary reaches the legal age (18 in England, Wales, and Northern Ireland; 16 in Scotland), at which point, the beneficiary gains full control.

In an Interest in Possession Trust, the beneficiary, or ‘life tenant', has an immediate and automatic right to the income from the trust, after expenses, as soon as it is produced. However, they do not have rights to the trust's capital, which is set aside for future beneficiaries, known as ‘remaindermen'. This type of trust is often used in estate planning to provide a surviving spouse with an income from the trust during their lifetime while preserving the capital for other beneficiaries, like children or grandchildren.

Discretionary trusts are distinguished by the significant amount of discretion granted to trustees. Trustees have the power to decide how, to whom, and when the trust's income and capital should be distributed among a nominated class of beneficiaries. This flexibility allows trustees to adapt to changes in beneficiaries' circumstances over time and offers potential benefits in tax planning and wealth preservation.

Accumulation trusts enable trustees to accumulate income within the trust and increase the trust's capital. Trustees can decide whether to distribute the income or add it to the trust's capital until a certain predefined event occurs, such as the beneficiary reaching a certain age. These trusts are often established for beneficiaries who are minors or not yet born, providing a means of accumulating and preserving wealth for future generations.

Word of Warning About Trusts…

Have you ever heard the phrase…'Power is useless without Control'? Trusts are one of many legal tools that can prove to be very powerful and beneficial if used in the right way, how they were designed to be used.

It is vital when discussing or planning to utilise trusts or you are perhaps a beneficiary of a really old trust and do not have the appropriate, qualified professional to guide you, so you and your family will end up the victors rather than the victims.

The timing of the trust creation is very important. There are also relevant tax laws specific to trusts that need to be understood and explained, else it will lead to significant problems including ten year anniversary charges, exit charges and possibly even entry charges of 20% (at the time of writing). This could affect your beneficiaries and not just yourself.

Selecting trustees without the proper advice could be absolutely destructive to all the planning and expectations you may have. More context regarding trusts can be found in our body of work called “Lifetime Trusts Explained” which will delve deeper into the subject matter including trusts and their taxation.

Again, it is highly advised you seek specialist advice regarding trusts. We offer a bespoke service regarding trusts and trust planning at ONCE WT.

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