Trusts are a vital tool in estate planning, providing flexibility, control and protection over how
assets are managed and distributed to beneficiaries. While the concept may seem complex, trusts can offer significant benefits when set up correctly. This guide will walk you through the main types of trusts available in the UK, their pros and cons and the importance of consulting an estates and trusts lawyer to ensure everything is legally sound.
Bare Trusts
A bare trust (also known as a simple or absolute trust) is the most straightforward type of trust. Under a bare trust, the assets are held in the trustee’s name, but the beneficiary has an absolute right to both the income and the capital. They are often used by parents or grandparents to gift assets to children.
Pros:
○ Simple structure: Bare trusts are the simplest trusts to set up and administer.
○ Tax-efficient: Assets in a bare trust are treated as the beneficiary’s for tax purposes, so any income or capital gains are taxed according to their personal tax allowances and rates.
Cons:
○ No flexibility: Once assets are placed in a bare trust, they are irrevocably owned by the beneficiary. You can’t change your mind about who receives the assets.
○ Lack of control: When the beneficiary reaches the age of majority, they gain full control over the assets, regardless of their maturity or financial responsibility.
Discretionary Trusts
In a discretionary trust, trustees have the power to decide how to distribute income and capital among a group of potential beneficiaries. The trust deed outlines who the beneficiaries are but leaves it to the trustees to determine how much each beneficiary should receive and when. Suitable for those wanting to maintain flexibility over how their assets are distributed, especially when beneficiaries are young or may have changing needs over time.
Pros:
○ Flexibility: Trustees can adapt their decisions based on the beneficiaries’ changing circumstances.
○ Asset protection: Discretionary trusts can protect assets from creditors, divorce settlements, or beneficiaries who are not financially responsible.
○ Tax advantages: Discretionary trusts can help in managing inheritance tax
(IHT) exposure, though they are subject to specific trust tax rules.
Cons:
○ Higher tax rates: Income generated by the trust is taxed at a higher rate than for individuals (45% for income and 28% for capital gains in some cases).
○ Complex administration: Managing a discretionary trust can be more time- consuming and costly due to the need for trustees to actively make decisions.
Interest in Possession Trusts
An interest in possession trust gives one or more beneficiaries the right to receive the income from the trust immediately. The capital (the underlying assets) will eventually pass to other beneficiaries at a later date, often after the death of the income beneficiary. Commonly used by people wanting to provide income to a spouse or partner during their lifetime, with the capital passing to children afterward.
Pros:
○ Immediate income: Beneficiaries receive income from the trust, typically from dividends or rental income.
○ Tax-efficient: Income is taxed at the beneficiary’s income tax rate, which may be lower than the trustee tax rate.
○ Control over capital: The capital remains protected for the ultimate beneficiaries (often children or grandchildren).
Cons:
○ No flexibility on income: The income beneficiary has a legal right to the income, so the trustees can’t change their decision about how much is distributed.
○ Potential IHT issues: The trust might be liable for inheritance tax, depending on the value of the trust and when the assets were transferred.
Charitable Trusts
A charitable trust is established to benefit a charitable cause or organisation. In the UK, to qualify as a charity, the trust must serve a public benefit and fall under one of the recognised charitable purposes (e.g., education, poverty relief, or religion). Ideal for individuals or families wishing to support charitable causes while benefiting from tax relief.
Pros:
○ Tax benefits: Charitable trusts benefit from significant tax relief, including exemptions from income tax, capital gains tax, and inheritance tax.
○ Good for legacy: A charitable trust allows you to leave a long-term legacy that benefits society.
Cons:
○ Limited flexibility: Once a charitable trust is set up, the assets can only be used for charitable purposes. You can’t reclaim the funds.
○ Strict regulations: Charitable trusts must comply with UK charity law and are subject to oversight by the Charity Commission.
Trusts for Vulnerable Persons
These trusts are designed to benefit individuals who are either disabled (physically or mentally) or under 18 and have lost a parent. The tax rules for such trusts are more favourable, and they ensure that vulnerable individuals are provided for without affecting their means-tested benefits. Best suited for individuals wanting to provide for vulnerable or disabled loved ones while protecting their financial security.
Pros:
○ Favourable tax treatment: Vulnerable persons trusts benefit from lower tax rates, helping to preserve the assets for the beneficiary.
○ Protection: Assets are protected and distributed in a way that won’t jeopardise the beneficiary’s access to government support.
Cons:
○ Complex to set up: Establishing a trust for a vulnerable person requires meeting specific legal criteria and may involve detailed tax planning.
○ Ongoing management: Trustees must carefully manage the trust to ensure compliance with tax and benefit rules.
Mixed Trusts
Mixed trusts combine elements of different trust types. For example, partof the trust might be set up as a discretionary trust, while another part provides an interest in possession. This allows the settlor to achieve multiple goals within one trust. Suitable for families or individuals with complex needs who want to combine the benefits of different types of trusts.
Pros:
○ Customisation: Mixed trusts offer the ability to tailor a solution to meet specific needs, such as providing income for one beneficiary while preserving capital for others.
○ Flexibility: The combination of different trust types allows for both flexibility and control.
Cons:
○ Complexity: Mixed trusts can be complicated to draft and administer, requiring detailed legal and tax planning.
○ Higher costs: Due to the complexity, setting up and managing a mixed trust typically involves higher legal and administrative fees.
Why Should I Consult an Estates and Trusts Lawyer?
Setting up a trust can be a powerful way to manage your assets and ensure they’re distributed according to your wishes. However, each type of trust has its own legal and tax implications, which can be difficult to navigate without professional guidance. Here’s why working with an estates and trusts lawyer is essential:
● Tailored Advice: A lawyer will assess your personal circumstances and advise on
the best trust structure to meet your specific goals.
● Avoiding Mistakes: Trusts must be set up correctly to ensure they are legally valid and tax-efficient. A lawyer will ensure all paperwork is in order and the trust operates
as intended.
● Managing Tax: Trusts can have significant tax implications, especially regarding inheritance tax and income tax. An experienced lawyer can help you minimise your tax burden.
● Legal Compliance: Trust law in the UK is complex, and there are ongoing compliance requirements. A lawyer can guide you through the legal process, ensuring the trust meets all regulatory requirements.
Trusts offer a wide range of benefits, from protecting assets to managing tax liabilities, but it’s essential to choose the right type for your needs. While some may seem simple, they often have long-term legal and financial consequences that require careful planning. Working with a qualified estates and trusts lawyer will help ensure that your trust is set up correctly, compliant with UK law and achieves your desired outcomes. Chat with us today for more information on how we can help you.