Top ten things to consider before preparing a trust

Families have used trusts for centuries to protect their wealth and maintain its value for the benefit of future generations. Whilst many people have heard of trusts, most struggle to understand exactly what they are and the benefits they can bring.

What is a Trust?

A trust is the formal transfer of assets (such as a property, shares or simply 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.
If the trust is to be made in your lifetime, to take immediate effect, then 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, then the trust rules must be set out in your will itself and would be 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 separation of the legal ownership and beneficial ownership, which were once inseparable, is the unique characteristic of the trust concept. The trustees are the legal owners but the beneficial owners are the beneficiaries.

Here we outline the top ten 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 asset into a trust, as this may influence what assets, and the value of the assets, you wish to put into the trust.

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

One reason might be because 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, or a spouse/civil partner, or it could also be 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, as well as 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 different types of trust to choose from and each of them 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 the establishment of the trust is advantageous to you from a tax perspective. Therefore it is important to 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 they are 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 longer period of time; 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 then you will need to consider ensuring that there is sufficient liquid assets 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 you 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 an extremely 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 as part of your estate planning.

10. Use a trust to safeguard compensation pay-outs

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

What are the different types of trusts?

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.

How do I set up a Trust?

It is always best to seek professional advice if you are thinking about setting up a trust. Contact us today to find out more about how we can help and guide you through the process.

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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 are holding 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 are looking after the money left in the estate after the payments of debts, funeral and testamentary expenses for the spouse.

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