Head of Private Client, Oliver Sharp explains the key characteristics of a trust and what you might need to know when creating one.
Recent statistics published by HMRC suggest that the total number of trusts (measured by those in the UK submitting self-assessment tax returns) fell by 6% in the tax year ending 2022 compared to the previous year. Wider statistics show a drop of approximately 14% over the past 5 years.
Does that mean the use of trusts is no longer something we need to think about as part of estate planning? Well, that is not really the full picture and is taking an over-simplified view. There are many reasons and circumstances where a trust may be beneficial.
A trust is a legal relationship created (in lifetime, or on death) by a settlor when assets are placed under the control of a trustee for the benefit of a beneficiary, or for a specified purpose. A trust has a number of characteristics:
- The trust assets are a separate fund and are not a part of the trustee's own estate.
- Legal title to the trust assets is in the name of the trustee, or in the name of another person on behalf of the trustee.
- The trustee has the power and the duty to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed on him by law.
The key characteristic of a trust is that it permits the separation of legal ownership and beneficial interest: the trustees become the owners of the trust property as far as third parties are concerned, and the beneficiaries are entitled to expect that the trustees will manage the trust property for their benefit.
Trusts are either express trusts (that is, a trust created intentionally by an act of the settlor), or trusts imposed by law. There are many different types of trust that can be set up. To highlight some of the most common types:
Bare trust – assets in a bare trust are held in the name of a trustee. However, the beneficiary has the right to the contents of the trust at any time if they are 18 years old or over.
Life interest trust – the ‘life tenant’ is entitled to all income arising and/or is entitled to live in and enjoy any property owned by the trust. On the death of the life tenant, or if their interest is terminated earlier, there will either be ongoing trusts or outright gifts for other beneficiaries.
Discretionary trust – the trustees have complete discretion to decide when to distribute income or capital, and to which of the named beneficiaries. This is the most flexible type of trust.
The tax regime appliable to trusts is complex but there are tax efficiencies. However, protecting assets and ensuring that control rests with appropriate people are usually the main drivers behind creating a trust – rather than necessarily tax.
A trust is a flexible mechanism that allows the person setting up the trust to maintain an element of control (with the trustees), while making the assets available to benefit the chosen beneficiaries. For asset protection purposes retaining assets within a trust helps maintain better protection than if held directly by a beneficiary (where they are vulnerable on the event of the beneficiary’s own death, divorce or bankruptcy).
There are many different situations in which a trust could be considered. This could be part of a lifetime estate planning exercise or under a Will. Wills often include some form of trust arrangement.
A common situation would be if you want to provide for a surviving spouse but make sure that the assets ultimately pass to your children. This is often particularly in consideration where there are children from a previous relationship. A life interest trust for your spouse (which should also benefit from spouse exemption for inheritance tax purposes) ensures appropriate provision for the spouse and the children would be the ultimate beneficiaries.
There could be a determination to provide for the whole of the estate to fall under a discretionary trust – allowing for wide flexibility in the hands of the trustees depending on the prevailing circumstances at the time.
Another area where the use of trusts can be advisable is for the ease of conduct and management of a privately owned business. Qualifying interests in a business can secure business property relief at a rate of up to 100 per cent for inheritance tax purposes and it can be beneficial for those business assets to be held distinct from the rest of the estate.
Trusts have ongoing compliance/reporting obligations and these are something that trustees need to be mindful of on taking up a trustee role. New wider rules have also recently come into force requiring UK trustees, and some non-UK trustees, to register trust details on HMRC's Trust Registration Service (TRS).
While there has been an overall decline in the number of trusts over recent years (as highlighted in the recent HMRC statistics) the use of trusts forms an integral part of an individual’s estate planning requirements and will continue to do so.