How do trusts work and should you use it for investments?

Written by Kellands Hale, an independent financial adviser.

This article is not intended to be financial advice to any individual. The views expressed are those of the author and Moneyfactscompare.co.uk does not endorse the content.

A trust is where a person (settlor) gives assets (such as money or property) to a third party (trustees) to look after for somebody else (beneficiaries).

Another way of viewing a trust is that it is a gift with conditions attached. A straightforward example would be a grandparent giving a sum of money to their grandchildren when they reach the age of 25. If the grandchildren are under 25, a trustee (usually their parents in this example) would look after the money until the grandchildren reach the age of 25 when it is handed over to them.

The trustees have a legal duty to manage the funds in accordance with both the law and the terms of the trust, which are usually set out in a ‘deed’ or a Will. Once an asset has been placed in trust, the trustees become the legal owners of the assets and the person creating the trust cannot usually get the items back if they change their mind. The rules around trusts are very complicated and it is important to take professional advice.

A family trust means different things to different people. The most common example is a discretionary trust where the members of a family (including their descendants) are named as beneficiaries. This can be a very good way of protecting assets long term, as events such as divorce or death of beneficiaries should not affect the funds in trust. Whether a trust is ‘worth it’ depends on an individual’s circumstances and what they are trying to achieve. An independent financial adviser will be able to advise on whether a family trust is appropriate for you.

Funds in a bank account can be placed into trust and it is very popular to place cash assets into trust. The starting point when placing assets into trust is to consider what it is you wish to achieve. An independent financial adviser will then be able to advise on the suitability of placing funds into trust and the type of trust that is appropriate to achieve your goals.

A trust should be seen as a tool within your estate planning arsenal rather than an alternative to making a Will. In fact, many Wills contain trusts and there can be benefits to protecting inheritance through trusts. If you need to discuss making a Will, then you should consult with a qualified solicitor.

There is no limit on how much or little you can put into trust provided there is an identifiable ‘object’ of some type, whether this is shares, money or property. This is because to create a trust, there must be an ‘object’ to be subject to the trust. If the intention is to create a trust and add to it later, it is quite common to place £10 into the trust to start it.

It is always sensible to take professional advice when creating trusts, particularly as the rules around trusts are very complicated. Usually a solicitor would create a trust and their fees often range from a few hundred pounds up to several thousand pounds depending on the type of trust required.

Whether or not there is a fee depends on how the trust is managed. The general position is that non-professional trustees (i.e. lay people) are not entitled to charge a fee for acting as trustees. However, professionals (such as solicitors) are entitled to charge a fee and this is often a fixed fee or an hourly rate. The fees are payable from the trust fund.

Moveable assets such as cars can be placed into trust, but caution must be exercised as placing a physical asset into trust can cause many problems. For example, if there is no cash in the trust, who pays for repairs or tax? If you are considering placing a car into trust, it is important to make sure there is cash available to cover running expenses. In most cases when cars are placed into a trust, they would usually be just one component and not the sole item.

Important matters to consider include its intended use (is it part of a collection or will it be used daily), the reason for placing it into trust (is it to enjoy it during your lifetime then pass it on to a museum or is it to keep it in the family long term) and the financial side (running and insuring the car).

There are a number of reasons to create a trust. This can include protecting an inheritance, protecting against care fees or wishing to give away an asset but with conditions attached (e.g. the gift can only be accessed at a particular age). Trusts can also be used as part of a tax planning strategy.

Trusts can avoid taxes in a number of ways. For example, creating a lifetime trust can ‘remove’ assets from your estate if you survive for seven years after making the gift. Creating a trust in your Will can mean you pass assets to beneficiaries without it forming part of their estate, which can avoid Inheritance Tax on their estate. It is very important to take professional tax planning advice when using trusts as part of a tax mitigation strategy.

Three of the most common types of trusts are Interest in Possession Trusts, Discretionary Trusts and Bare Trusts.

An Interest in Possession is a trust where a person (life tenant) has the right to the income from the trust and/or use of the assets (e.g. live in the house) for a set period of time (often a person’s lifetime). When that trust ends, the assets pass onto someone else (either directly or as part of a trust).

A Discretionary Trust is where the trustees have control over how to use the trust income and capital. For example, they can decide which beneficiaries to pay, how much to pay and when to make payment.

A Bare Trust is where an item is to be held on trust by trustees for somebody else (usually until they reach a certain age) and that person is then entitled to all of the income and capital. However, the beneficiary can ask for the trust funds to be paid to them at any time if they are over 18.

The best type of trust is one that meets your wishes and personal requirements. There is no one type that is best as such. However, Flexible Life Interest Trusts are very popular in Wills and due to the tax treatment of trusts, Discretionary Trusts are very common when setting up trusts in lifetime.

It is very popular to leave a house in trust in your Will due to the many advantages offered. For example, if you wish to give the surviving spouse a home to live in for their lifetime but do not want them to have control over what happens to your share of the house if they meet someone else after you die. This can give protection to the inheritance as the survivor would not have control over your share of the house and you can effectively ringfence it for your children.

Placing your house in trust during your lifetime is less popular as it doesn’t have many benefits compared to the pitfalls. For example, if you give away your house (into trust) but still live in your house, then in most circumstances it would still form part of your estate for Inheritance Tax. It can also be seen as a ‘deliberate deprivation of assets’ by the local authority in relation to means-tested care fees so it is very important to take professional advice before making any decision about placing your house into trust.

Trusts can be a very good way of giving assets away while providing protection against events that could cause the inheritance to be lost such as the beneficiaries divorcing. Depending on the type of trust used, they can provide long-term protection for the trust funds and will not be affected if the beneficiaries die, divorce or are made bankrupt.

Placing assets into trust can also have tax advantages as it can be used to protect against Inheritance Tax. For example, if a parent wishes to make a gift to a child whose estate would be subject to Inheritance Tax if they die, they could place the assets in trust so that the child has access to the funds but the funds would not form part of their estate if they die (and therefore avoid Inheritance Tax).

Trusts can also be a very good way of protecting an inheritance for a vulnerable person. For example, a disabled person’s trust can be created that gives protection for that person.

Trusts can also be used to protect compensation payments received in respect of personal injury claims. The funds received can be ringfenced so that they do not affect any state benefits.

By handing over control of the trust to trustees, you are losing control over the assets. Although careful drafting of trust documents can give you some control (e.g. as a trustee), there has to be a limit on your control otherwise there is a risk that the trust is seen as still being owned by you and therefore any advantages to the trust can be lost.

Trusts are subject to a number of reporting requirements (e.g. trusts must register with HMRC) and this can cause a significant amount of administrative work.

Although a trust can have tax advantages, there are a number of tax disadvantages. Trusts are chargeable lifetime events and can use up your Nil Rate Band (Inheritance Tax allowance). If the value placed into trust exceeds the Nil Rate Band, it can cause Inheritance Tax to be paid immediately. Many trusts are also subject to a stringent tax regime called the ‘Relevant Property Regime’. This means that in addition to potentially paying Inheritance Tax when the trust is created, there can also be charges to Inheritance Tax every 10 years and when payments are made from the trust. Income and gains are also taxed at the ‘trustee rate’, which is currently equivalent to the highest rate of tax.

Strictly speaking you do not need a lawyer to create a trust. However, the rules around trusts can be very complicated and there can be significant tax consequences if you get it wrong. Therefore, it is always sensible to take professional advice when setting up a trust.

Kellands (Hale) Limited {“Kellands”) is a firm of Chartered Independent Financial Advisers and our scope of authorised business activity under Financial Conduct Authority (FCA) regulations is restricted to advising and arranging life insurance, pensions, investments, protection, mortgages and general insurance contracts. Kellands is not authorised as legal specialists, accountants or tax advisers. It may be appropriate for you to seek specialist legal advice on tax matters when considering the potential benefits and drawbacks of placing assets into trust. This guidance on trusts has been prepared by Kellands with the support of trusted legal representatives and is intended as a high-level overview, which is provided as information only and should not be relied upon in isolation.