What is a Trust?
A Trust is a legal arrangement, which enables its creator (‘the Settlor/Testator’) to leave your assets in the care of another person or persons (‘the Trustees’) The Trustees manage these assets for the benefit of other people or organisations, whom you support (‘the Beneficiaries’). In its simplest terms a Trust is ‘a gift with strings attached’.
A Trust is the most common way of providing for a loved-one, who would be unable to manage alone or maybe irresponsible with money, or even be a child or someone suffering from mental health problems. These Trusts are normally set up by a person’s Will on their death but they can also be set up during a person’s lifetime.
What type of Trusts are there?
Essentially there are five types of modern Trusts, which are:
- A Discretionary Trust
- Accumulation and Maintenance Trusts
- A Life-interest Trust
- Protected Trusts
- A Bare Trust
Choosing a Trust
The type of Trust that you choose and how it is worded will depend upon your circumstances and your objectives. Trusts are generally used in wills as a tax planning exercise, as well as ensuring provision for those loved ones who may not be capable of making the right decisions themselves. Trusts can become quite complicated so it is very important that professional advice is sought from an experienced lawyer.
A Discretionary Trust is where your Trustee can use the capital and/or the income of your assets for the benefit of a number of beneficiaries – this is known as the ‘Class of Beneficiaries’. These people are chosen by you, as are your Trustees. No beneficiary has any right to require the Trustees to exercise their discretion in their favour. This means that Discretionary Trusts are particularly effective in avoiding means testing. If, for example, one of the beneficiaries was in receipt of means tested benefit, the Trustees would be able to distribute funds to that person, perhaps by paying for a holiday, without those payments being taken into account in any means testing. A Trust of this kind can continue for any period between three months to 80 years from the date of its creation. It must contain a final provision, which states who will be entitled to anything which remains in the Trust when it does come to an end. These Trusts can be found in any number of situations, but most frequently in:
- Wills for Inheritance Tax planning purposes.
- Trusts set up during your lifetime for Inheritance Tax planning.
- Trusts to hold benefits of insurance policies.
- Trusts to hold benefits arising under Personal Pension Plan or a Death in Service benefit.
Accumulation and Maintenance Trusts
These are a special form of Discretionary Trust, set up for the benefit of child beneficiaries. There are special rules set down by the Inland Revenue that give the Trust taxation advantages. They work by accumulating any income arising from within the Trust, other than income used to provide for the maintenance, education or benefit of an infant beneficiary. These Trusts are often used in practice where grandparents wish to benefit grandchildren.
Life Interest Trusts
This type of Trust is where a beneficiary has an entitlement to receive the income from the Trust’s property or investment during their lifetime and then on their death that interest passes on to other persons or charities of your choice. The basic structure of such a Trust is the payment or entitlement to payment of income from the Trust as it arises to one or more people (‘the life tenants’) during his or her lifetime. On the death of the life tenants the capital and income pass to other individuals (‘the remaindermen’) of your choice.
Any property or funds held in trust for life will not be treated as a capital resource when entitlement to State benefits is assessed. However, any income arising from the Trust will be taken into account if the life tenant is in receipt of means tested benefits.
These are a special type of Life Interest Trusts known as Protected or more traditionally Protective Trusts. Historically these were used by parents concerned that a financially extravagant child may become insolvent or be too easily influenced by others to give away property or money.
This type of Trust has now become popular because it combines the advantage of the flexibility that a Discretionary Trust provides together with the certainty of provision of income to the main beneficiary that a Life Interest Trust provides. This is particularly useful where parents wish to safeguard the financial future of a child who, although not legally incapable of managing their own affairs, may need protection from situations that could result from their mental difficulties.
Under this type of Trust the money or property is given to the Trustees with the instructions to them that the income that arises from it would then be paid to the main beneficiary, either for their life or alternatively for a fixed period of time (which is specified). If the beneficiary tries to sell an asset from the Trust, the provisions of the Trustee Act 1925 apply and their right to receive the income under the Trust will be stopped. The Trustees then hold the income on a Discretionary Trust for the benefit of the beneficiary, their spouse (if any) and children (if any). This effectively prevents the beneficiary from selling their right to the income. In the unlikely event that the beneficiary becomes bankrupt the same provisions would apply, thus protecting the Fund.
As in the Life Interest Trust the assets left under a Protected Trust do not belong to the beneficiary and therefore will not be treated as a capital resource when entitlement to State Benefit is assessed. However, the income arising from the Trust will be taken into account in calculating Means Tested Benefit.
Finally, you must state in the Trust who would benefit from the assets after the death of the main beneficiary and this could be any of your other relatives, friends or even a charity or charities.
This is where all of the funds are held by Trustees for the benefit of the proper owner. Bare Trusts generally occur when the main part of another Trust has come to an end, but the monies and properties have to be held before they are paid over to the beneficiaries. These Trusts are rarely used in tax planning matters, but are useful in some circumstances.
Finally, there are specialist types of Trust which are used for the benefit of mentally incapable persons and further information in these can be obtained from MIND (the National Association for Mental Health), The Down’s Syndrome Association or MENCAP. MENCAP in particular have their own special type of Trust for the benefit of mentally incapable relatives. Details can be obtained direct from them – the address is at the end of this fact sheet.
Understanding how a Trust works
It is important that you choose people to act as Trustees carefully, as they should be aware of your loved ones’ needs, as well as being able to look after the Trust fund financially. You can appoint up to four Trustees, but the minimum number possible is two. Acting as a Trustee can take up considerable time and effort and it is important that you get that person’s agreement before appointing them. You can appoint a stand-in Trustee who could then act if anything happened to one of your original Trustees during the lifetime of the Trust.
Powers of the Trustees
Whatever type of Trust you decide to set up you should consider giving your Trustee the widest possible powers to deal with the assets and your legal adviser will be able to give you all the details of these. These will probably include powers of investment and insurance and also directions as to how the money should be applied for the benefit of your loved ones. Your legal adviser will also be able to advise on the Statutory Provisions of the new Trustee Act 2000 which will apply.
Letters of Wishes
To assist your Trustees in making decisions you can write a letter to them, explaining why the Trust was set up and what you want it to achieve. Particularly in the case of a Discretionary Trust, your letter can also include your wishes as to how you would like the Trust fund to be used for all of the beneficiaries and whether it should favour any one or more of them.
It is important to realise that a letter of wishes is not legally binding on your Trustees but it is particularly helpful to them if your Trust is set up on your death by in your Will and you will not then be available to offer them guidance.
Taxation of Trusts
The different types of Trusts are all taxed in different ways. The detail of how each trust would be taxed is beyond the scope of this introductory fact sheet. However, our experienced advisers will be able to go through the taxation implications in detail with you in relation to the type of trust that you may be considering. If you wish to find out more detail yourself the Inland Revenue produce a useful booklet in their Personal Taxpayer Series entitled ‘Trusts – An Introduction’. This leaflet can be obtained direct from the Inland Revenue at the address given at the end of this fact sheet.
MENCAP produce a useful booklet entitled ‘Leaving Money by Will to People with Learning Disabilities’. Copies can be obtained free of charge by writing to:MENCAP 123 Golden Lane London EC1Y 0RT
Phone: 020 7454 0454
The Down’s syndrome Association produce a detailed booklet entitled ‘A guide to families wishing to make legal provision for a learning disabled member’. Copies can be obtained free of charge by writing to:Down’s Syndrome Association Langdon Down Centre 2a Langdon Park Teddington TW11 90S
Phone: 0845 230 0372
MIND, the mental health charity, also produce a special free booklet entitled ‘Making Provision’. Copies of this publication can be obtained free of charge by writing to:MIND (The National Association for Mental Health) 15019 Broadway London E15 4BQ
Phone: 020 8519 2122
The Inland Revenue produce a leaflet IR152 – ‘Trusts – An Introduction’ (Personal Taxpayers Series) which can be obtained free of charge from:Inland Revenue Order Line PO Box 37 St Austell PL25 5YN
Or from their website: www.inlandrevenue.gov.uk/leaflets
The Capital Taxes Office also produce the following booklets:
- IHT16 ‘Inheritance Tax – Settled Property’
- Explaining the rules for charging Inheritance Tax on assets included in a settlement or trust.
- IHT3 ‘Inheritance Tax An Introduction’
- Explaining about Inheritance Tax in general.
Copies of these can be obtained free of charge from:Capital Taxes Office Ferrers House PO Box 38 Castle Meadow Road Nottingham NG2 1BB
Phone: 0115 974 2400
Or can be downloaded via the website: www.inlandrevenue.gov.uk/cto/leaflets
We believe the information contained herein to be correct as at 20th September 2008. Whilst all possible care is taken in the compilation and presentation of this fact sheet, no responsibility for loss, occasioned by any person acting or refraining from acting as a result of the material in the fact sheet, can be accepted by the firm or the author.