What are Trusts?
In basic terms a Trust is a way of giving someone or a group of people the benefit of certain assets, without giving them direct control over them. Technically a trust does not even need to be documented, it can be verbal, although in practice any major planning would want to be documented through a ‘deed’.
A trust is a separate legal entity and involves three main roles. A ‘Settlor’ establishes a trust and usually gifts/settles assets into it. There are then ‘trustees’ who legally own and manage assets on behalf of ‘beneficiaries’, who have the beneficial interest in those assets.
In the case of a trust with discretionary powers of appointment, the trustees have discretion over how, when and for which beneficiaries assets can be used. This can provide those establishing trusts with a great deal of control over the assets, as they will usually also be trustees.
N.B. it is usually the case that the settlor will be specifically excluded from being able to benefit from the trust, to avoid any ‘reservation of benefit’ for inheritance tax (IHT) purposes.
Will Trusts
Trusts can be established during life, or by a will on death – known as will trusts. Using will trusts can be a useful way of achieving legacy objectives for many people.
Leaving assets to a will trust is an alternative to leaving assets directly (absolutely) to an individual. The reasons for doing this would be protection and control. Assets left outright to a beneficiary may be exposed to a number of potential threats, such as from divorce and creditors.
A risk could potentially apply to assets left to a surviving spouse; in the event they remarried their assets could pass to their new spouse on their death, running the risk of disinheriting your children. It could also potentially apply to assets passing to your children e.g. being lost in a future divorce settlement or to creditors in the event of a failed business venture. By gifting assets into a trust there is some potential scope to reduce these risks.
There could be concerns over how that money was spent e.g. whether it would all be used constructively (most common with younger beneficiaries). As such, having a trustee in place to control timing of access could be useful.
The main drawback to using will trusts is the additional complexity (and to an extent, cost) compared to absolute gifting. The role of trustee is also key; you need someone who you could trust to perform the role, particularly on the death of a surviving spouse. A professional can provide this but comes with an associated cost.
For further information on wills, please see our Guide to Making a Will.
Liftime Trusts & Gifting
Lifetime gifting is generally undertaken to help family members and reduce Inheritance Tax liabilities. Settling assets on trust during lifetime is an alternative to gifting assets directly to individuals.
The main benefits and drawbacks of using trusts compared to absolute gifting are very similar to those described above for using trusts in wills. Generally speaking, using a trust will be more effective when the aim is to protect assets and reduce Inheritance Tax liabilities, rather than gifting sums for immediate help of a family member e.g. paying off a mortgage, home improvements etc.
There are a couple of specific types of lifetime trust that can provide Inheritance Tax benefits whilst providing the settlor with some access to income or capital (which may be preferential to an outright gift) and one which can provide an immediate Inheritance Tax benefit. Further details are set out in our Guide to Inheritance Tax Planning.
Do Trusts save Inhertiance Tax (IHT)?
Trusts are not primarily a tool for reducing tax liabilities, although ultimately they can help achieve this in the right circumstances. Gifting money into a trust (either on life or death) will not usually save any Inheritance Tax compared to making a gift to someone outright, at least initially.
A tax benefit of trusts can eventually come from intergenerational planning, keeping assets outside of any individual’s estate, therefore avoiding successive charges to Inheritance Tax (e.g. on your death and then on your children’s death when passing onto your grandchildren). This benefit is somewhat tempered by the fact that trusts are subject to periodic Inheritance Tax charges every ten years (at a maximum of 6%).
Trusts can also be very useful in stopping assets entering your, or your spouse’s/widow’s estate and increasing Inheritance Tax liabilities. Life insurance policies should almost always be written into trust. Similarly, pension death benefits (at least where death occurs before age 75) may also be better passing into a trust for your family, rather directly into a spouse’s estate. Finally, if you are due to inherit additional amounts, you could consider effecting a ‘Deed of Variation’ to receive amounts into a trust for the benefit of you and your family, rather than receiving them outright.
Trusts can also be advantageous when it comes to obtaining probate for an estate. Assets within the estate cannot be accessed until probate is granted (which usually takes several months), but probate will only be granted once the Inheritance Tax has been paid. Assets within trust (which are outside the deceased’s estate) can be available immediately and could provide funding for the tax.
Should I use Trusts?
Successful estate and legacy planning is essentially about getting the right money into the right hands at the right time. Depending on your aims and financial circumstances, establishing trusts may well play a part in this (an up to date will almost certainly does).
With lifetime gifting into trusts, an important question is how much wealth you will personally need to protect your own lifestyle (and that of your widow/er) for the rest of your life/ lives. That requires careful financial planning, which is the starting point for our advice with every client.
With both lifetime gifting and will trusts, consider what you would like your wealth to achieve. Think in terms of results- the people you want to benefit and the effect on their lives you want to have.
Depending on the outcome to these questions, trusts may be appropriate for you (but not necessarily). Estate planning can be a very complex and emotive topic. If you would like to discuss this further, please do talk to us about it.
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