Trusts are tax efficient and afford flexibility to a person who wishes to pass assets to certain people during their lifetime or upon their death.
A trust is a legal relationship created (either during lifetime or on death) by a person (the settlor) placing assets under the control of another person or persons (the trustees) for the benefit of others (the beneficiaries). For example, A transfers his property to his trustee, B, who becomes the legal owner of the property and holds the property on trust for the benefit of A’s children, C and D.
The benefits of trusts
By transferring your assets into trust whilst you are alive, you may be able to reduce the value of your estate on your death and your consequent inheritance tax liability.
You may also be able to reduce any capital gains tax liability arising on increases in the value of your assets through the use of trusts.
Tax law changes frequently so you may want to take advantage of current, beneficial tax reliefs by transferring your assets into a trust in advance of any change in the law or your circumstances meaning that the relief is no longer available.
There are reasons other than financial ones for setting up a trust. A trust can protect your assets from a family member’s divorce or future bankruptcy. You may want to protect someone who is vulnerable or currently unable to manage their own finances or wish to provide for your family in the future, by using a trust to support minor and unborn children or grandchildren.
In these circumstances, a trust can provide for the intended beneficiaries without giving them full control of the assets within. You could even appoint yourself as a trustee to retain some measure of control yourself.
Types of trusts
There are a number of different categories of trusts and the one you choose will depend on your and your beneficiaries’ personal and financial circumstances. The most frequently used trusts are known as a discretionary trust and a life interest trust.
Discretionary trusts
A settlor gives to his or her trustees the control over an asset or assets, and it is ultimately for the trustees to decide exactly which of the settlor’s specifically named or class of beneficiaries should benefit. The settlor can tell the trustees what they would like them to do, but this is not legally binding and the final decision rests with the trustees. This allows them to take into account the beneficiaries’ future circumstances and is particularly useful where the settlor wishes to benefit minor/unborn children, vulnerable beneficiaries or charities.
Using trusts effectively
Life interest trusts
In a life interest trust the trustees hold the assets, transferred by the settlor, on trust for a particular beneficiary (the life tenant). The life tenant will usually have the right to any income the asset produces or, if the asset is a property, the right to live in the property for the rest of their life. In some circumstances, for example where the life tenant is the settlor’s widow(er), the settlor may also state that the interest comes to an end if the life tenant remarries or lives with someone else before he or she dies. After the life interest comes to an end, the assets will then pass to specified beneficiaries, or remain in trust for their benefit, as set out in the trust document.
This is a useful arrangement where a settlor wants someone to benefit for the rest of their life, but for the asset(s) ultimately to pass to someone else. A life interest trust is often used following second marriages where the settlor wishes to benefit a second spouse during their lifetime but then for their assets to pass to children of a first marriage.
The practicalities of trusts
To set up a trust during lifetime, a settlor would usually execute a trust deed, appointing the trustees, detailing the powers the trustees will have, and setting out the people (or institutions) who should benefit from the trust’s assets. The assets would then be transferred to the trustees, who will become the legal owners of the assets.
To set up a trust to take effect after death, a settlor would include similar provisions to those of a lifetime trust in their will.
Conclusion
It may be that setting up a certain type of trust would be suitable in light of your own personal and financial circumstances. You might be concerned that your children may go through a divorce or bankruptcy and wish to protect any assets you wish to give to them. You may simply want to withhold certain assets until you feel your children are at an age to deal with such assets responsibly. A trust can also provide flexibility, which in turn opens up a number of useful tax planning opportunities.
