What Are Trusts? A Comprehensive Guide to Trusts
Introduction: A Guide to Different Types of Trusts
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Trusts are legal arrangements that allow a trustee to manage and distribute assets on behalf of a beneficiary. In simpler terms, assets, ranging from cash savings to real estate holdings, are controlled by a trusted person appointed by their owners.
Whether you are considering setting up a trust for estate planning, asset protection, or tax advantages, this guide aims to break down the basics.
What is a Trust?
A trust is a legal arrangement where one person, known as the settlor, transfers assets into a trust to be managed by another person, the trustee, to benefit a third person, the beneficiary. The terms of the trust are usually set out in a document called the ‘trust deed.’
Why Set Up a Trust?
Trusts are often used for a variety of reasons:
- Asset Management: Trustees manage the trust assets for the beneficiary.
- Tax Planning: Trusts can offer certain tax advantages, including reducing inheritance tax.
- Estate Planning: Trusts can help in distributing assets after one’s death.
Key Components of a Trust
The person who creates the trust is known as the settlor. The settlor transfers assets into the trust and decides how the assets will be managed and distributed.
The trustee is responsible for managing assets placed in trust. They must adhere to the terms of the trust deed and have the power to decide how to manage the trust assets for the beneficiary best.
The beneficiary is the person or entity that benefits from the trust. They may receive income or capital from the trust assets according to the terms set by the settlor.
This legal document sets out the terms of the trust, including the powers and duties of the trustee. The trust deed is the backbone of any trust arrangement.
Types of Trusts
This is the simplest type of trust where the beneficiary has an absolute right to the trust assets and income generated.
In a discretionary trust, the trustees can decide how to distribute the income and capital among the beneficiaries.
These are trusts where the settlor or their spouse/civil partner benefits directly from them. The settlor could have set it up due to various factors that prevent them from managing the assets themselves, such as ill health.
This type of trust is very complex, and various tax rules apply based on the domicile status of the trustee, the settlor, and the beneficiary. It is always best to consult with a professional advisor in these matters. Please fill out the contact form on the right, and one of our specialist team will contact you.
Note that depending on the type of trust and its terms, it may be subject to different tax rules, including inheritance and capital gains tax.
Benefits and Drawbacks of Using Trusts
Benefits: Asset Protection
One key benefit of using a trust is the ability to protect your assets. For example, the assets in the trust are not part of the settlor’s estate, offering some protection against creditors.
Trusts offer a structured way to pass assets to beneficiaries, potentially reducing inheritance tax liabilities.
Control of Assets
The settlor can also benefit from the assets while maintaining control through the terms of the trust deed. This is sometimes called a ‘settlor-interested’ trust and has special tax rules.
Peace of Mind
Trusts can provide peace of mind that assets will be managed and distributed according to your wishes, especially for minor children or others who cannot manage assets themselves.
Trusts can be complex to set up and manage. Trustees must understand their duties and responsibilities, and the trust may require regular accounting and legal oversight.
Setting up and maintaining a trust can be costly, especially if you need to consult a solicitor and financial advisor for specialised advice.
While trusts can offer tax advantages, they also have their own set of tax rules and potential liabilities, including capital gains tax and a potential tax charge upon transferring assets into a trust.
Trusts and Legal Considerations
Role of a Solicitor
Consulting a solicitor is crucial if you want to set up a trust. A solicitor can explain the legal requirements, help you draft the trust deed, and advise you on the types of trust that might suit your needs.
Trust Laws in England and Wales
Trust laws in England and Wales are governed by a combination of statutory and case laws. If you are considering setting up a trust, it is crucial to consult professionals who understand the specific legal landscape.
Local Authority and Trusts
Sometimes, trusts are used to protect assets when a person is assessed for local authority care. However, the local authority can assess assets transferred into a trust if they believe it was done to avoid paying for care costs.
Trustees have a legal obligation to act in the best interests of the beneficiaries. They are responsible for managing assets held in the trust and must adhere to the terms set out in the trust deed.
Tax Implications of Trusts: What You Need to Know
Inheritance Tax and Trusts
Inheritance tax is among the most significant considerations when setting up a trust. Sometimes, trusts can reduce inheritance tax, but it is crucial to note that trusts are subject to their own tax rules.
Capital Gains Tax
Capital gains tax may apply when assets are sold or transferred within a trust. This tax rate will depend on the type of trust and the assets involved.
Trust income, such as rent or dividends, may also be subject to income tax. The trustee is generally responsible for managing this aspect of the trust.
Special Tax Rules
Certain trusts, like ‘settlor-interested’ trusts, have special tax rules. To fully understand the tax implications, consulting a financial advisor like Jack Ross, who is familiar with trusts, is essential.
Practical Aspects of Trusts: From Creation to Management
Creating a Trust
Creating a trust usually involves drafting a document called the trust deed, which sets out the terms of the trust. A solicitor typically prepares it; at least one trustee must be named in the deed.
Managing the Trust
Managing a trust involves various duties, including investing assets, filing tax returns, and making distributions to beneficiaries. Trustees must adhere to the terms of the trust deed and act in the beneficiaries’ best interest.
Making Changes to a Trust
Some trusts are revocable, meaning the settlor can change the trust at anytime. Others are irrevocable, meaning that once the trust is set up, it cannot be altered without the beneficiaries’ consent.
Dissolving a Trust
Trusts can usually be dissolved or wound up according to the terms set out in the trust deed or when their purpose has been fulfilled, such as when a beneficiary reaches 18.
Trusts for Special Circumstances
Charitable trusts are set up to benefit charitable organisations rather than individual beneficiaries. These trusts often have tax advantages and are subject to different regulations.
Trusts for Life Insurance Policies
Life insurance policies can be placed into trusts to ensure the proceeds are managed according to the settlor’s wishes. This can be especially useful when the beneficiaries are minors or financially inexperienced.
Advanced Trust Concepts
Irrevocable vs. Revocable Trusts
Once created, an irrevocable trust cannot be changed, while a revocable trust allows the settlor to make changes. The choice between the two often depends on your goals for control and flexibility, and tax considerations.
Interest in Possession Trusts
In this type of trust, one beneficiary has a right to the income generated by the trust. In contrast, another may have a claim to the capital. These trusts are often used in family planning and have unique tax considerations.
Absolute Right and Discretion
In a bare trust, beneficiaries have an absolute right to the capital and income generated by the trust. In contrast, in a discretionary trust, trustees can decide how to distribute assets.
Trusts as a Versatile Tool for Asset Management and More
Trusts offer a flexible way to manage various financial planning goals, from asset protection and inheritance planning to tax advantages. However, they are complex instruments that require a solid understanding and professional advice. Whether you are considering setting up a trust for the benefit of minor children, to manage life insurance policies, or for more complex estate planning purposes, it is crucial to consult with professionals to ensure you are making the most of this versatile financial tool.
Jack Ross has a wealth of experience in dealing with trusts, from the early planning stages to advice on tax planning strategies. If you are in need of our services, use the contact form below and one a member of our dedicated team will be in touch to discuss next steps.
Sometimes the settlor can also serve as a trustee or even benefit from the assets in the trust, but this is generally subject to special tax rules.
While there should be at least one trustee, it’s generally recommended to have at least two trustees, especially for larger trusts, to distribute responsibility and liability.
A wide range of assets can be placed in trust, including money, property, stocks, and private company shares. The type of assets you choose to transfer will depend on your financial goals and the needs of your beneficiaries.