Trusts can play an important role in helping clients achieve their financial and estate planning goals.
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So, it is worth making sure you are familiar with what trusts are, the different types of trusts available, how they are created, as well as the legal requirements and tax implications.
Clients need to be fully informed about the benefits, but also the responsibilities and limitations of using trusts.
Trusts can be useful in a host of scenarios including inheritance tax planning, asset protection, control over asset distribution, supporting minors or dependants, charitable giving, growing wealth and long-term care planning.
What is a trust?
A trust is commonly understood to be a legal relationship where trustees manage property for the benefit of beneficiaries.
Trusts can be created for a specific purpose, either during someone’s lifetime or upon death. They can also be imposed by law.
They can be set up by a trust deed, which outlines the rules for managing the trust property and dispersing it to beneficiaries, or by a will.
Trusts are governed by the different legal systems in the UK.
Tax rules and trust laws can change over time, which could affect the trust’s effectiveness or benefits.
Regular reviews are essential to ensure they remain suitable for your clients.
Trusts must be dated, signed and witnessed to be valid, and they require three certainties:
- Intention – words to create the trust.
- Objects – beneficiaries must be identifiable either named or in classes.
- Subject matter – relating to the trust property being legally owned by trustees and must be identifiable.
The main parties to a trust are:
- Settlor/donor – creates the trust and gives the original gift.
- Trustees – selected by settlor/donor/court to manage and administer the trust property. They can be individuals or professional trustees/trust company.\
- Beneficiaries – the people who benefit from the trust property. They can be, along with their rights, named at the outset or defined by classes.
Why use a trust?
The primary reason, for using a trust is control. It ensures assets are managed and passed on according to the settlor’s wishes.
The settlor retains control by selecting those individuals to manage that property on their behalf and more often than not are also trustees themselves, maintain that control over the assets.
For absolute trust, the settlor controls from the outset who can benefit and their shares, and once established these cannot be changed.
For interest in possession (IIP) trusts there is usually a named life tenant who has the right to the property or income from the trust property during their lifetime.
Then, the remaindermen, usually defined by classes, have the rights to the capital once the life tenant dies or if they give up their rights during their lifetime, which would be a potentially exempt transfer for IHT purposes.
For discretionary trusts, the beneficiaries are defined by classes and none of the beneficiaries have any entitlement to any of the trust property.
Who benefits, when and by how much, lies solely in the discretion of the trustees.
Using trusts for estate and IHT purposes is a tried and tested method of developing a holistic plan.
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The value of the gift should help reduce or negate any potential IHT due and will be outside the estate after seven years. Growth on the gift is usually outside from day one.
The type of gift will be classified for IHT purposes as a potentially exempt transfer (Pet) when gifts are made to absolute, disabled, or bereaved minor’s trusts and chargeable lifetime transfers (CLT) when made to relevant property trusts such as discretionary trusts and IIP trusts created after March 22 2006.
Consideration should be given to the types of gifts made, the order they are made as well as the tax impact this could have on the donor/settlor at the time the gift is made, ongoing and if death occurs within seven years.
The Court of Protection could award a payment either directly to a personal injury trust to provide for the claimant’s future needs and wellbeing or paid to thatperson/their deputy if they do not have the capacity to manage their own affairs to establish a personal injury trust.
When looking to establish a personal injury trust, consideration should be given to the 52-week disregard for means-tested benefits.
This is a period of grace for an individual already in receipt of means-tested benefits to set up a trust and protect the compensation payment if established within 52 weeks of first receipt.
There can be no expenditure before trust set up or the Department for Work and Pensions will review this to establish whether any deliberate asset deprivation has taken place.
Using a trust may protect assets from bankruptcy and creditors, depending on the type of trust used.
Trusts allow provisions to be made for vulnerable persons who do not have the mental capacity to deal with their own affairs and to provide for minors who do not have the legal capacity to own those assets at that time.
Where there are complex families and second marriage, trusts allow the direction of wealth to go to who you want it to, and most importantly exclude those you do not.
Trustees cannot distribute trust assets to individuals not either named as a beneficiary or defined in a class.
Assets owned by trustees are not part of someone’s estate for probate purposes.
This can be extremely useful at a time when the legal representatives are dealing with the estate.
Depending on the terms of the trust, the trustees may be able to do an interest free loan to the legal representatives to pay for things such as funeral arrangements, debts and IHT before probate has been granted.
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Probate can be a lengthy process depending on the complexity of the estate, so at a time of immense personal grief, a quick and easy payout of funds is very welcome.
Common types of trusts and suitability
Probate trust
This can be created on either an absolute or discretionary basis and assets owned by the trustee do not form part of the estate for probate purposes. This type of trust is a settlor interested trust as the donor/settlor has access to the trust property throughout their lifetime and is taxed as such.
So, while it is not IHT efficient, it is efficient from an estate management point of view.
If a discretionary trust is used the trustees should be willing to take on the reporting requirements and ensure any trust registration service (TRS) requirements are completed.
Gift and loan/loan trusts
These are for people who may be unable or unwilling to make outright gifts at this time but want to achieve IHT savings on the growth. They can be on a discretionary or absolute basis, so the gift (if applicable) will be CLT or a Pet and while usually covered by an exemption, this is not always the case, so if discretionary the trust will be subject to the relevant property tax regime and all that brings.
Like any loan, this needs to be repaid by the trustees to the settlor/donor and usually done utilising the 5 per cent tax deferred withdrawal facility if an investment bond is 5used. Any outstanding loan remains inside their estate for IHT purposes, but growth is outside from day one.
The client can never have more than the loan repaid to them due to gift with reservation of benefit rules. The loan is made interest free to the trustees and repayable on demand, though care is needed around this as a full repayment could cause a chargeable event gain (if a bond is used) and income tax due.
The tax efficiency of how the loan is repaid either by partial or full policy surrenders or a combination of the two depending on the history of the bond needs to be considered.
The loan can be waived making this into a gift (Pet or CLT) to the trust or to an individual, but again care should be given to the type of trust involved as there could be tax consequences for doing this.
Provision for how the personal representatives should deal with any outstanding loan should also be considered and included in the will.
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Flexible reversionary trust
This involves the settlor transferring a bond or a series of endowment policies into trust and retaining the right to benefits in the form of:
- an amount of the money invested (%);
- a cash sum; or
- policy maturity proceeds.
All other benefits are held for the beneficiaries.
The settlor’s retained rights can be defeated or deferred by the trustees. Because of this, the settlor’s retained rights have no open market value, and they make a transfer of value equal to the full sum invested on set up.
Discounted gift trusts
This type of trust allows individuals to make an IHT-effective gift while retaining access to fixed withdrawals for life/until the fund is depleted. This is important when it comes to assessing the suitability as in most cases, once started these cannot waived, altered, or stopped and accumulated withdrawals may reduce the IHT efficiency. These withdrawals or ‘retained rights’ are the only access clients will have, they cannot access the rest of the trust fund.
The gift can provide an immediate IHT saving if a discount is agreed subject to underwriting, so gifts over nil-rate band might be achievable. This is why clients considering this type of trust should be in good health, under 90-years-old and the underwriting should be completed before the trust commences.
Growth on the trust property is outside the estate from day one and a gift will be outside after seven years.
It can be created on a discretionary or absolute basis, making the gift a CLT or Pet. If discretionary, relevant property regime applies and reporting requirements should be considered.
A discounted gift trust can be written on a single or joint settlor basis. There are pros and cons for each, especially if there is a large age gap or health differences between the clients and if the clients want access to the fund after the settlor/donor has died and not just the retained rights.
While it might be permitted by the trust deed for trustees to make distributions to the beneficiaries while the settlor or donor are still alive, it is unusual to do so unless in an emergency.
Advice should be sought as the trustees’ duty to ensure there is enough in the trust fund to fulfil the retained rights requirements is paramount.
Gift trusts
The donor/settlor gifts a lump sum to the trustees for the benefit of either named or a wide range of classes of beneficiaries.
The donor/settlor will not have access to any withdrawals or the capital of the trust fund so this needs to be affordable.
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These trusts can either be created on a discretionary or an absolute basis but the discretionary version will be subject to the relevant property. Reporting requirements should be considered.
Gift outside their estate after seven years, growth from day one.
Bypass trust
The main aim was to ‘bypass’ the surviving spouse/civil partner’s estate by paying lump sum death benefits from a pension to a trust. The spouse/civil partner could still benefit but it would be outside their estate for IHT purposes.
Most are discretionary, giving trustees discretion over who benefits, when and by how much, so would be relevant property for taxation purposes. Also, if the scheme member dies post-age 75, consideration should be given to whether a bypass trust would be the most suitable from an income tax point of view.
The scheme member completes a nomination of wishes form asking the pension trustees to consider paying the death benefits to the trust rather than individuals. The trustees have discretion about who to pay death benefits to, which will currently be free from IHT, but there are changes to brining pensions into IHT scope post-April 2027.
It is created by a gift (usually exempt) of £10 to the trustees with no other additions to the trust until the death benefits are paid in to it.
After death benefits have been paid, the trustees will need to invest the funds for the benefit of the beneficiaries and take advice where appropriate.
The choice of investment will be key and the reporting requirements for the trustees considered as well as the administration and costs, which is why investment bonds are popular solutions.
Will trust
Trust written into the will comes into force when the testator dies.
The will contains the details of the trustees, the trust property, how this should be managed and the beneficiaries. Commonly they are either discretionary, an IIP or an immediate post interest trust. Taxation and reporting requirements should be considered.
Immediate post death interest trust
An IIP trust that gives an immediate interest on death of settlor via the will.
It usually gives rights of occupation of a property/right to income to life tenant during their lifetime and then to the person who stands to inherit on the life tenant’s death.
Should the life tenant give up their right to the property or income then this will be a Pet and will remain in their estate for seven years.
Most pensions are created under a master trust scheme and the fund grows free from income, capital gains and IHT in most cases, though changes around IHT are due from April 2027.
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New limits on tax-free lump sums and death benefits apply, though beneficiary drawdown designated to income is excluded from new limits.
Consulting professional paramount
There are many different types of trust solution that will be suitable for clients to use at various stages of their financial life cycle.
Using multiple and several types of trust along the financial planning journey will add value to client’s financial plans, though the order of gifting and the seven and 14-year rules need to be remembered.
Trusts are wonderful holistic planning tools to use with your client so long as they are understood, and the correct one chosen for the circumstances of that individual(s).
It is always best practice to consult with legal and tax professionals to ensure the implications are fully understood before establishing a trust arrangement as most are irrevocable.
