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Published 15 April 2024
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What is a Trust and Why Set One Up?

Trusts can be a useful way to reduce inheritance tax, but they can also protect your assets so they are passed to the people you care about in the way you would like. Here’s why trusts could be worth considering as part of your estate plan.

Trusts are not just for people who are well off. While they can minimise inheritance tax, they are also a useful tool to protect assets for your beneficiaries, giving you control over how those assets are managed and distributed. This can include instructions about what will be paid out and who will benefit, along with any other conditions that are important to you.

There are all sorts of purposes for trusts and a number of types available. The rules are extremely complex, with tax implications depending on the type of trust. This is why getting the advice of a solicitor or financial adviser is essential before committing to using any form of trust.

Even so, understanding the basics is worthwhile if you think a trust might help you pass on your assets in the way you would like.

What is a trust?

A trust is a legal arrangement where a person or company known as the trustee controls assets, which must be used for the benefit of other people, known as beneficiaries. Once your assets are in a trust they no longer belong to you, but are held in the trust for whoever you want to benefit from them.

This means trusts are treated outside your estate when you pass away, which can reduce the amount of inheritance tax (IHT) you pay.

There are three parties in a trust, each with different roles:

  • The settlor sets up the trust and puts their assets into it.
  • The trustee manages and controls the trust for whoever the settlor wants to pass the assets to, in line with wishes set out in the trust deed or will trust.
  • The beneficiary is the recipient of the assets in the trust. There can be more than one beneficiary, and they can be anyone, including individuals, charities or organisations, even future grandchildren.

Different types of trust have different tax implications and uses that can come into effect in your lifetime, or when you pass away.

» MORE: Understand how inheritance tax works

What assets can you put in a trust?

You can put almost any asset you own, including property, investments and cash, in a trust. When you put your assets in a trust and meet its conditions, they are no longer considered yours and may not be counted towards your IHT liability.

However, some trusts and assets attract income tax and capital gains tax. There may also be IHT to pay at certain times for some trusts, such as when you transfer the assets at the start, and then periodically every 10 years after the creation of the trust.

While the trustee pays any tax due, as the settlor, you need to tell HMRC about the tax your trustee has paid when you complete your tax return.

Who can be a trustee?

Trustees must be over 18. They can be a member of your family or a friend, or you can choose a professional trustee. A settlor can also be a trustee, depending on the type of trust used.

If you’re setting up a will trust, which takes effect after you pass away, the executor named in your will could also be your trustee.

You can have one trustee or a number of trustees. As you are passing your assets into their care, they will need to understand their legal responsibilities and the rules of the trust. They should also always act in the best interests of the beneficiary.

If the trust is subject to income tax, capital gains tax or inheritance tax, the trustee must pay what’s due and tell HMRC about the trust. You can find details about the records the main trustee needs to keep on the government website.

What are the benefits of trusts?

Passing on as much inheritance as possible and using available tax benefits, along with protecting and controlling assets for your beneficiaries are the overarching benefits of using a trust.

But there are other reasons, such as protecting assets for a time when you may be unable to care for yourself, or even making sure someone doesn’t inherit your assets.

Here are some examples where trusts might be beneficial, and the relevant types of trusts you might come across:

  • You want your children to inherit funds that are held in the trust when they reach 18, but not before. A straightforward bare trust may be used for this purpose.
  • You want income earned from shares you hold paid out to your partner and, when your partner passes away, ownership of the shares to pass to your children from a previous marriage. The same could apply to income from a property you rent out. An interest in possession trust may be used for this.
  • You want your sibling to act as trustee and make decisions that are in the best interests of your nieces or nephews, who are your beneficiaries. Decisions could be who receives what and when, or even about investments. A discretionary trust may be used for this.
  • You want to protect assets for a beneficiary who is vulnerable because they have a disability, or a child who has lost a parent. This may also attract special tax treatment, and make sure means-tested benefits aren’t affected. A trust for vulnerable beneficiariesmay be used for this.
  • You want you and your spouse to benefit from the capital and income from an asset if you’re ill and can’t work, where the trustee would pay you. This would be a settlor-interested trust. If you need long-term care, these payments would be considered during any assessment for local council support.
  • To hold a life insurance policy, so it won’t be considered part of your estate and may be exempt from inheritance tax. You can also give directions about how the lump sum will be distributed. There are a few types of trust for this, including an absolute trust.

A solicitor can help identify which type of trust is right for you based on what you’re looking to achieve, the tax implications and how complex your estate is.

What are the downsides of trusts?

With all the potential benefits of trusts, they are a legal arrangement that should be given careful thought. You and your trustee should be aware that:

  • There are tax and legal implications that come with using a trust.
  • The role of trustee carries responsibility and can be complex and time-consuming. The duty can also last many years.
  • Once the trust is set up it can be hard to revoke or change, unless the type of trust you’re using offers that option.
  • If the trustee doesn’t act in the best interests of the beneficiary, they may face legal action.
  • It can be expensive to set up, depending on the type of trust.

How to set up a trust

If you think a trust might be right for you, you can ask a solicitor to set one up. You can search for a wills, trusts and probate solicitor through the Law Society and STEP.

The cost of setting up a trust depends on the type of trust and your circumstances, but it can start at around £1,000. If you’re putting a life insurance policy into a trust, your provider may do this at no extra cost.

It’s important to set the terms out clearly and correctly to prevent issues later on. This includes clearly naming trustees and beneficiaries, and stating when it will be effective – whether that’s straight away or when you pass away.

A solicitor or financial adviser can help explain tax rules around trusts and will take these into consideration before setting it up.

» MORE: Nine steps to consider in your estate plan

Image source: Getty Images

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