There are three main types of trust to be aware of.
Discretionary trust
This type of trust affords your chosen trustees with a very wide range of authority to manage the trust assets – including how the beneficiaries receive any benefit from the trust. The key element of a discretionary trust is that no one beneficiary has an absolute right to receive either, income generated by the trust assets (e.g. dividends, interest, rental income) or to receive any capital.
These types of trust are very widely used because they enable the trust assets to be distributed in what the trustees deem to be the most tax efficient or practical way, depending on the circumstances at the time they make the decision.
As none of the chosen beneficiaries have an absolute right to either income or capital, none of the trust assets are deemed to be theirs and they will therefore not generally impact their entitlement to receive benefits, or form part of their own estate for inheritance tax purposes.
Although you cannot seek to hinder your trustees’ discretion as to how the trust assets are used, you can seek to guide them and influence their decision through the use of a ‘letter of wishes’. This confidentially informs your trustees how you envisage them using the trust assets. They can, if having considered all the relevant circumstances, exercise their discretion to follow your wishes. Because of the amount of discretion your trustees can exercise, it is vital you select the appropriate people to act in this role.
Interest in possession trust
This type of trust generally affords one or more individual with the right to receive an income from the trust assets, or occupy and property that the trust may own. That chosen beneficiary is usually referred to as a life tenant because they are normally given that right to receive the income for the rest of their life. Generally, your trustees do not have the discretion to deprive that chosen beneficiary, or beneficiaries of that right, and any income generated by the trust must be paid over to them.
Given that the beneficiary does have a right to receive income from the trust, this will have an impact on their own tax position when they receive the income, when they die, and if they dispose of the asset. Ordinarily, if a beneficiary of these types of trust dies, the value of the underlying trust assets are combined with their own assets when calculating any inheritance tax liability.
Your trustees must balance the entitlement of the life tenant to receive a reasonable income, and therefore maximise the same, while also maintaining and safeguarding the value of the underlying capital assets for the ultimate beneficiaries who will receive the capital when the life tenant dies, or otherwise forgoes their entitlement.
Bare trusts
These are the most basic type of trust structures. Effectively, the trustees hold a defined amount or share of both the capital and income for the benefit, or one or more individuals who are absolutely entitled to both. For all tax purposes, the underlying trust assets are treated as though they are held in the beneficiary’s own hand (with certain exceptions for minor beneficiaries).
The beneficiary can insist that the trust assets are transferred into their name, provided they have reached 18 years of age.
Bare trusts are particularly useful as a means of accurately recording the true beneficial ownership of an asset, while the legal title is still vested in another. For example, should a minor inherit a property, their name cannot appear on the legal title because minors cannot hold property in their name. Consequently, a parent or guardian may instead own the legal title in their name, but they will hold the beneficial entitlement as bare trustee for the minor beneficiary. When that minor becomes 18, they can, at that point, have the legal title to the property transferred into their name so that the legal and beneficial ownership become aligned.
The tax rules around these different types of trust are complex and must be carefully considered before a decision is made.
