Setting up a trust: 10 things to consider

Families have used trusts for centuries to protect their wealth and maintain its value for future generations. In this guide, we’ll discuss the following:

• Understanding what a trust is
• Why are trusts important?
• Different types of trusts
• Things to consider before preparing a trust
• Checklist: How do I set up a trust?

While many people have heard of trusts, most struggle to understand exactly what they are and the benefits they can bring.

Understanding what a trust is

A trust is the formal transfer of assets (such as property, shares, or cash) to a small group of people, usually two or three, known as “trustees,” with instructions that they hold the assets for the benefit of others.

1. A legal arrangement where assets and income are held by one party, known as the trustee, for the benefit of another party, known as the beneficiary.
2. Within the structure of a trust, there are three key roles: the settlor, the trustee, and the beneficiaries. Each has distinct functions as defined in a legally binding document called the Trust Deed.
3. The settlor is the individual who establishes the trust and transfers assets into it, creating the trust fund. They decide the terms of the trust and choose the trustees and beneficiaries.
4. The trustee is the individual or entity responsible for managing the trust assets according to the deed. Trustees have legal ownership of the assets and must act in the best interests of the beneficiaries.
5. Beneficiaries are the individuals or groups that benefit from the trust. They have a right to benefit from the trust assets or income as specified in the trust deed but do not have legal ownership of the assets.

If the trust is to be made in your lifetime and takes immediate effect, it is usually evidenced by a trust deed and often referred to as a ‘settlement’. If it is to be created on or shortly after your death, the trust rules must be set out in your will and known as a ‘will trust’.

Whether created by lifetime settlement or by a will, the trust document states who is responsible for looking after the gifted assets (the trustees), who is to benefit (the beneficiaries), and any rules or conditions to which the trustees and beneficiaries must adhere. The unique characteristic of the trust concept is the separation of legal ownership and beneficial ownership, which were once inseparable. The trustees are the legal owners, but the beneficial owners are the beneficiaries.

What does held-upon trust mean in a Will?

It depends on how the will is drafted, but the term generally means that the executors hold the assets upon trust for the beneficiaries. For example, a will might instruct the executors to hold their residuary estate upon trust for their spouse. This simply means that the executors look after the money left in the estate after the debts, funeral, and testamentary expenses for the spouse are paid.

Why are trusts important?

Understanding their importance can help you make informed decisions about your assets and legacy.

Different types of trusts

1. Discretionary Trust

In a discretionary trust, trustees have wide authority to manage trust assets and determine how beneficiaries receive benefits. No individual beneficiary has an absolute right to receive income or capital from the trust assets.

A discretionary trust offers the best flexibility and control for trustees.

Key features include:

• Trustees have broad authority to manage trust assets
• No beneficiary has an absolute right to income or capital
• Trustees decide how and when beneficiaries receive benefits
• Useful for tax-efficient distribution of assets
• Beneficiaries’ entitlement to benefits is generally not affected
• Assets don’t typically form part of beneficiaries’ estates for inheritance tax
• A ‘letter of wishes’ can guide trustees’ decisions

These types of trust are 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 when they make the decision.

As none of the chosen beneficiaries has an absolute right to income or capital, none of the trust assets are deemed theirs. Therefore, they will not generally impact their entitlement to receive benefits or form part of their own estate for inheritance tax purposes.

You can guide your trustees’ decisions using a ‘letter of wishes’ to inform them about how you want the trust assets to be used. The trustees can choose to follow your wishes at their discretion. Selecting the right trustees is crucial due to the considerable discretion they have.

2. Interest in Possession Trust

This type of trust generally affords one or more individuals the right to receive an income from the trust assets or occupy 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 to them.

This type of trust provides a right to income or use of assets for specific beneficiaries.

Characteristics include:

• One or more beneficiaries (life tenants) have the right to receive income or occupy trust property
• Trustees generally can’t deprive the chosen beneficiary of this right
• All income generated must be paid to the life tenant(s)
• Impacts the beneficiary’s tax position
• The value of underlying assets may be included in the beneficiary’s estate for inheritance tax purposes
• Trustees must balance income generation with capital preservation

Given that the beneficiary does have a right to receive income from the trust, this will impact 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 is combined with their own assets when calculating any inheritance tax liability.

Your trustees must balance the life tenant’s entitlement to receive a reasonable income and, therefore, maximise it 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.

3. Bare Trust

These are the most basic types of trust structures. Effectively, the trustees hold a defined amount or share of both the capital and income for the benefit of 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 hand (with certain exceptions for minor beneficiaries).

The beneficiary can insist that the trust assets be transferred into their name, provided they have reached 18 years of age.

The simplest form of trust, bare trust, has the following features:

• Trustees hold a defined amount or share of capital and income for specific beneficiaries
• Assets are treated as if held directly by the beneficiary for tax purposes (with some exceptions for minors)
• Beneficiaries can claim the assets at the age of 18
• It is helpful in recording true beneficial ownership when another party holds legal title
• Often used when minors inherit property

Bare trusts are beneficial 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.

Each type of trust has complex tax rules that must be carefully considered before a decision is made. It’s advisable to seek professional advice to determine which trust structure best suits your needs and circumstances.

Things to consider before preparing a trust

1. Identify the assets you want to give away

This could be cash, property, or even shares in a business. It is important to appreciate the different tax implications of transferring these different types of assets into a trust, as this may influence what assets and their value you wish to put into the trust.

2. Consider the reasons for wanting to give your assets away

One reason might be that you would otherwise face an inheritance tax bill if you still own the assets when you die. Read out more about how personal tax planning, including creating trusts, can assist with minimising tax liabilities.

Another reason may be that you simply wish to ensure that others, such as your children, can benefit from the assets now because you do not need to anymore. It could also be part of a wider estate planning exercise involving the procurement or sale of a business. Once you’ve thought about why you want to give the assets away, it will help form your decision on whether a trust is the best option for you.

3. Decide who will act as trustees and safeguard the assets

This could be you, a spouse/civil partner, or other family members or close friends. It is worth noting that professionals can also act as trustees.

4. Decide who will be named as the beneficiaries of the trust

This could be named individuals or a class of beneficiaries, such as your “children” or your “siblings”. Trusts are a useful way of safeguarding assets for vulnerable beneficiaries as they can protect them and the funds into the longer term.

5. Review your options and decide what type of trust is most suitable for the beneficiaries

There are several types of trust to choose from, each of which affords the trustees and beneficiaries different responsibilities or rights respectively. Each one is treated differently for tax purposes so it is important to select the right one.

6. Understand the practical implications of setting up a trust

Once assets are transferred into a trust, it is generally the case that you cannot benefit from those assets again. This is often to ensure that establishing the trust benefits you from a tax perspective. Therefore, you must ensure you do not need access to these assets once you have given them away.

The trustees also need to be prepared to file tax returns for the trust, prepare trust accounts, hold trustee meetings and otherwise ensure ongoing administration and safeguarding of the assets is managed.

7. Think about your long-term plan for the trust

Trusts can be in place for up to 125 years if non-charitable. While it is often the case that more modern trusts do not last this long in reality, you should think about who you would want to benefit from the assets if they remain in the trust for a more extended period; for example, your grandchildren, wider family members or a charity.

8. Assess whether you expect your trustees to seek legal and tax advice to assist them in administering the trust

If your trustees are likely to need legal advice and support when administrating the trust, you will need to consider ensuring that sufficient liquid assets are in the trust to meet the costs of obtaining the advice—your trustees are not obliged to use their personal funds to discharge these costs.

It is also worth noting that if you are a trustee yourself and pay these fees on the trustee’s behalf, you will, in effect, be ‘adding to the trust fund’ each time you contribute to the fees.

9. Consider if you’d like to benefit charitable causes

A charitable trust can be a highly effective way of ring-fencing assets for the exclusive benefit of charitable causes close to your heart. There are many tax advantages too, if a trust is set up for these purposes. Read more about how a charitable trust can be included in your estate planning.

10. Use a trust to safeguard compensation pay-outs

A trust can be used to protect personal injury or medical negligence compensation. Still, you must seek this advice before, or as soon as possible after, you have been awarded the funds. A personal injury compensation trust can be an effective way of ring-fencing your compensation so it doesn’t impact your entitlement to certain benefits.

Checklist: How do I set up a trust?

If you are considering setting up a trust, it is always best to seek professional advice. Contact us today to learn more about how we can help and guide you through the process.

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In general, you’d need the following:

• Passport or driving licence (for identification)
• Recent utility bill or bank statement (for proof of address)
• National Insurance number
• List of assets to be placed in the trust
• Names and contact information of proposed trustees
• List of intended beneficiaries with full names and contact information
• Letter of wishes (to guide trustees on your intentions)
• Most recent tax return

Homeowners

• Property deeds
• Mortgage documents
• Home insurance policies
• Council tax statements

Young Families

• Marriage certificate
• Birth certificates of children
• Life insurance policies
• Details of children’s bank accounts or Junior ISAs

Unmarried Couples

• Cohabitation agreement (if applicable)
• Jointly owned property documents
• Details of shared bank accounts or investments

High Net Worth Families

• Investment portfolio statements
• Details of offshore accounts or trusts
• Art or valuable collectibles appraisals
• High-value insurance policies

Family Businesses

• Business ownership documents
• Company accounts for the last three years
• Shareholders’ agreements
• Business succession plans

Elderly Parents

• Pension statements
• Care home fee plans (if applicable)
• Power of Attorney documents
• NHS Continuing Healthcare assessments (if applicable)

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Known for our personal touch, we approach dealing with trusts individually with sensitivity and meticulous attention to detail.