Trusts

What Is a Trust?

A trust is best understood as a relationship where:

• Settlor: The person (or persons) who creates the trust and transfers assets (money, property, shares, etc.) into it.
• Trustees: The individuals or professional bodies appointed by the settlor to manage those assets. Trustees have a legal duty to act in the best interests of the beneficiaries.
• Beneficiaries: The people or organisations (for example, charities) who are meant to benefit from the assets held in trust.

The assets within a trust no longer belong to the settlor. Instead, they belong to the trust itself, under the control of the trustees. The trust’s terms (laid out in a legal document called a trust deed) specify how and when the beneficiaries will benefit.

Reasons for Creating a Trust

People set up trusts for a variety of personal or financial reasons:

• Asset Protection: Keeping certain assets out of an individual’s personal estate can provide some protection if they face future financial risks or business liabilities.
• Estate Planning and Inheritance: Trusts can help ensure assets pass to chosen beneficiaries under specific conditions, potentially reducing inheritance tax or avoiding probate delays.
• Provision for Dependants: Trusts allow the settlor to support children, vulnerable family members, or anyone else who may require guidance in managing their finances.
• Wealth Preservation: Long-term trusts can preserve family wealth over generations, ensuring that assets are not depleted or mismanaged.
• Controlling Asset Distribution: If someone wishes to transfer assets (like property or investments) while still maintaining some control over how they are managed or used, a trust can be an effective framework.

Key Parties in a Trust

1. Settlor

The originator of the trust, who provides the assets and sets the rules for how they should be managed and distributed.

2. Trustees

Individuals or corporate entities entrusted with managing the assets as specified in the trust deed. They owe a fiduciary duty to the beneficiaries, meaning they must act in the beneficiaries’ best interests, follow the trust terms, and maintain impartiality among multiple beneficiaries.

3. Beneficiaries

Those who benefit from the trust assets. They may receive income, capital, or both, depending on the trust’s terms. Some beneficiaries are entitled to their share outright, while others may only have a future or discretionary interest.

4. Protector (optional)

Some trusts appoint a protector (or adviser) who oversees the trustees’ actions. The protector might have powers such as appointing new trustees or vetoing certain decisions. This role is less common but can be useful in complex, high-value, or international trust arrangements.

Common Types of Trusts in the UK

While the details can get intricate, most UK trusts fall into a few main categories. The right choice depends on factors such as who the beneficiaries are, how flexible distributions need to be, and what the overall goals are for the settlor.

1. Bare Trusts (Absolute Trusts)

A Bare Trust is the simplest form. The beneficiaries have an immediate and absolute right to both the trust’s assets and any income generated. Once the beneficiary turns 18 (16 in Scotland), they can demand that the trustees transfer the assets to them outright.

• Key Use: Often used for children or young adults. The assets are held by trustees until the beneficiary reaches adulthood.
• Advantages: Simple structure, fewer ongoing administrative requirements, potential inheritance tax advantages if the settlor survives seven years from creation.
• Disadvantages: No flexibility once the trust is established—beneficiaries gain full control at the specified age, regardless of their maturity or circumstances.

2. Discretionary Trusts

A Discretionary Trust gives the trustees broad discretion over how and when to distribute trust income and capital among a class of beneficiaries. The trust deed specifies who those beneficiaries can be (e.g., children, grandchildren), but does not fix the proportion or timing of distributions.

• Key Use: Useful for settlors who want to provide flexibility in how assets are used for family members, especially if their needs or circumstances might change over time.
• Advantages: Trustees can respond to beneficiaries’ changing needs (e.g., educational expenses, medical costs), and assets can be protected from a beneficiary’s creditors if handled correctly.
• Disadvantages: Higher administrative burden and potentially higher tax rates on undistributed income. Trustees must track and justify their distribution decisions carefully.

3. Interest in Possession Trusts (Life Interest Trusts)

With an Interest in Possession Trust, a beneficiary (often referred to as the “life tenant”) has the right to receive any income the trust generates for their lifetime, but they do not own the underlying capital (referred to as the “trust capital”). When the life tenant dies or the trust period ends, the capital passes to other beneficiaries, often called the “remaindermen.”

• Key Use: Common in estate planning, particularly for couples in second marriages. It can provide the surviving spouse with income for life while preserving the capital for children from a previous marriage.
• Advantages: Balances two sets of interests: one beneficiary receives income now, and others receive the remainder later.
• Disadvantages: May be less flexible than a discretionary trust; the life tenant’s share is fixed to income only.

4. Mixed Trusts

A Mixed Trust (or hybrid trust) combines elements of different trust types within the same arrangement. For example, part of the trust might be a discretionary component, while another portion could provide an interest in possession for a particular beneficiary.

• Key Use: When a settlor needs distinct rules for different portions of their estate (e.g., discretionary powers for a portion that might be used for younger relatives and an interest in possession for an elderly parent).
• Advantages: Provides tailored solutions within a single structure.
• Disadvantages: Administration and tax considerations can become more complicated.

5. Accumulation and Maintenance Trusts (A&M Trusts)

Historically, Accumulation and Maintenance Trusts were popular for children or grandchildren, allowing trustees to accumulate income until beneficiaries reached a certain age. In more recent years, changes in tax legislation have altered how these trusts are taxed, making them less distinct from discretionary trusts. However, some legacy A&M trusts remain.

• Key Use: Ensuring trust income is reinvested for minors or young adults until they reach a specific age, often between 18 and 25.
• Advantages: Once a staple for children’s inheritance.
• Disadvantages: Post-2006 rules aligned many A&M trust tax treatments with those of discretionary trusts, slightly reducing their unique advantage.

6. Vulnerable Beneficiary Trusts

A Vulnerable Beneficiary Trust is designed for beneficiaries who are either physically or mentally disabled, or who meet certain criteria (for instance, a trust for a child whose parent has died). It offers favourable tax treatment provided strict conditions are met.

• Key Use: Ensuring disabled or otherwise vulnerable individuals have funds available for their care without compromising state benefits or subjecting them to undue financial complexity.
• Advantages: Generally lighter tax burden if qualifying rules are met, ensuring the maximum benefit for the vulnerable individual.
• Disadvantages: Strict eligibility criteria must be adhered to, and trustees must maintain detailed records and comply with the relevant regulations.

7. Non-Resident Trusts

A Non-Resident Trust is set up in a jurisdiction outside the UK, potentially offering tax advantages if neither the trustees nor the trust assets are primarily based in the UK. These structures tend to be used by individuals with international ties or those considering cross-border asset protection.

• Key Use: International wealth planning, especially if the settlor or beneficiaries live abroad or if assets are held overseas.
• Advantages: Can reduce or defer certain UK tax obligations if properly structured.
• Disadvantages: Complex rules on residency and domicile; setting up and maintaining a non-resident trust often requires specialised legal and tax advice.