If you’re thinking about protecting your wealth, providing for loved ones, or managing assets with more control, setting up a trust could be the ideal solution. Trusts have been used for centuries as a practical and effective way to ensure assets are distributed according to your wishes. Whether you’re planning for future generations or looking for a structured way to manage your estate, trusts offer flexibility, peace of mind, and significant tax advantages when done right.
But how do they work, and what are the key considerations? From understanding the basics of trusts to exploring the different types and their tax implications, this guide will walk you through the essentials.
Let’s start by looking at what trusts are and how they can help you safeguard your financial legacy.
What are trusts?
Trusts date back to the Middle Ages, when knights would transfer their land to a trusted third party before leaving to fight in the Crusades. The idea is the same today: you (the settlor) transfer assets to be held by a third party (the trustee), usually for the benefit of someone else, like a child or grandchild (the beneficiary).
The settlor can be a trustee and also a beneficiary. However, the settlor being a beneficiary is uncommon as it makes the trust ineffective for inheritance tax (see below).
Types of trusts
There are multiple types of trusts that will suit a diverse range of needs. Let’s take a look at a few.
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Bare trusts
Bare trusts are the simplest form of trust, often used to pass assets and the income they earn to younger people. The trustee looks after the assets but the beneficiary has the right to all capital and income of the trust at any point if they are 18 or over (in England and Wales), or 16 or over (in Scotland).
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Interest in possession trusts
These trusts see the trustee pass on all trust income to the beneficiary as it arises (less any expenses). For example, if you create a trust for all the shares you own and the terms say that when you die, the income goes to your spouse for the rest of their life. When they die, the shares pass to your children. In this case, your spouse has an “interest in possession” in the trust.
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Discretionary trusts
Discretionary trusts are where the trustees have the power to make decisions about how to use the trust income, and sometimes the capital. For example, they may be able to decide what gets paid out, how often and to whom. They are a good option for particularly young beneficiaries or beneficiaries who are unable to deal with money themselves.
Trusts and tax
How trusts are taxed is a complex topic, but let’s try to summarise the essentials here.
- Income tax: Most trusts do not pay income tax on income up to a tax-free amount (normally £500). Tax on the income above this amount will vary between different types of trusts. For example, non-dividend-type income in discretionary trusts will be taxed at 45%, compared to 20% in interest in possession trusts.
- Capital gains tax: Tax is usually paid by the settlor when selling or transferring the asset to the trust. The trustees usually have to pay capital gains tax if they sell or transfer the assets on behalf of the beneficiaries, except if the trust is a bare trust.
- Inheritance tax: Inheritance tax is usually 40%, applied to certain estates. But some types of trusts are treated differently. For example, transfers into a bare trust may be exempt from inheritance tax as long as the settlor survives for seven years after making it. That’s why they’re increasingly popular for inheritance tax planning.
Legal and administrative requirements
Setting up a trust involves drafting a trust deed, which outlines its purpose, the assets involved, and the role of the trustee. The trustee legally must properly manage the trust’s assets in a way that maximises the benefit of the beneficiary. They must also keep detailed records and are responsible for any tax filings.
Additionally, trustees must ensure compliance with relevant laws, such as anti-money laundering (AML) regulations. Consulting a qualified solicitor or financial adviser is highly recommended to ensure the trust is established correctly and remains compliant with legal and tax obligations over time.
Looking to set up a trust? Get in touch with us today. We’ll do everything we can to help.