Financial Mortgage Advice

What are trusts and why would you use one

Trusts have many different uses, depending on what you want to achieve with your money.
Here we run through the most common reasons to set up a trust.

 

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What is a trust

A trust is a way of managing your assets, whether they are money, investments, buildings or land. There are different types of trusts and they are taxed differently. 

 

Setting up a trust can provide peace of mind knowing that the care you have provided the people and possessions you love will continue.  Knowing which type of trust is best suited for your needs and how to begin can be daunting, which is why we wanted to share some foundational knowledge to help you in your financial wellness journey.

Keep control

Trust can ket you maintain control over the assets you’ve placed in the trust.  This can be done under the terms of the trust but it is usually done by acting as the trustee.

Establishing a trust under a Will can help ensure the assets in the trust are passed to the people you want at the right time after you pass away.  This can be useful if, for example, there are children from previous marriages that need to be dealt with fairly.  A trust can help ensure that the current spouse is taken care of for the rest of their lives, after which the remainder of the estate can pass to their children from the other relationship.

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Help to protect assets

Trusts can be a way of protecting certain assets for a beneficiary.  If a gift is made to a beneficiary, who later goes bankrupt or divorces for example, then the gift may be lost.  Yet if the gift was made into a trust in which the beneficiary has no rights to the assets gifted, then the gift is much less likely to be taken into account.  This is possible because the trustees may decide not to pass the gift onto that beneficiary.

Saving on inheritance tax

Trusts can also be used as a useful way to save on inheritance tax.  And this can also be done without the need to make an outright gift to another person.

If your assets are placed into a trust, and you are unable to benefit from these assets, then after 7 years they will fall outside your estate for inheritance tax purposes.  An additional benefit is that any growth in the assets while they are in the trust, will immediately be outside your estate.

Avoiding delay with probate

Upon death, inheritance tax (and any fees related to probate) must be paid before probate can be granted.  Until probate is granted your assets cannot be distributed in line with your Will.  A problem can arise as the executors of your Will need to pay the tax and charges but are unable to use the estate’s assets until probate is granted, meaning they need to find the funds from elsewhere.  However, trustees can access any money held within a trust with no need to wait for probate, as the trust is a separate entity outside of the estate.  This money can then be used to pay the inheritance tax bill and any probate fees.  There is also the added possibility of setting up a life insurance policy where the proceeds are paid directly into a trust.  This means that any funds paid out upon death from the policy would remain out outside the estate and could be used to pay an inheritance tax bill.

Different types of trust

There are many different types of trusts in the UK, each with different purposes and tax rules. These are some of the most commons ones:

Absolute or Bare Trusts

With an absolute or bare trust, the legal owners of the assets are the trustees, but the beneficiaries maintain an “absolute” entitlement to the assets.  Upon reaching age 18 (16 in Scotland) the beneficiaries can demand and receive their share of the trust’s assets.  This type of trust cannot be altered once the trust has been set up, the beneficiaries cannot be changed or removed.

Interest in Possession Trust

An interest in possession trust (also known as a life interest trust or a life rent trust in Scotland) gives beneficiaries the right to occupy a property or to receive an income from it.  Under an interest in possession trust at least one of the beneficiaries must have the right to any income arising from the trust.  The beneficiary may also be referred to as the “life tenant” (“life renter” in Scotland).  Upon the death of the life tenant, the trust assets are then passed to the other beneficiaries.

Discretionary Trusts

As the name implies, a discretionary trust allows the trustee’s discretion over how much and when, and to which beneficiaries the trust money is paid out to.  These types of trust provide the greatest flexibility in terms of how the trustees manage the assets in the trust.  They are often accompanied by a “letter of wishes” from the settlor (who set up the trust) which provides guidance to the trustees on how the trust is to be distributed.  This is non binding, however, and the trustees make the final decision in how the funds are distributed.

A Discretionary Trust may be suitable suit you if you have identified a particular group of people you want to benefit but you are unsure which of them, in the future, will need help or in what proportions. 

For example, as a grandparent, you might like to set aside capital for all of your grandchildren, although some of them may be born after your death.  Some of them might be more in need than others and family and financial circumstances could change from year to year, making it difficult to know ahead of time how to apportion the trust between the potential beneficiaries.

Loan Trusts

A loan trust can be used to keep access to the settlor’s money whilst giving away any potential growth.  When the loan trust is set up, the settlor will lend money to the trustees who will then invest it on the settlor’s behalf.  As the settlor retains the ability to request the repayment of part or all of the loan at any point, the loaned money remains inside the settlor’s estate for inheritance tax purposes (this is different from most other trusts where the assets are deemed to be out of the estate for inheritance tax purposes.)  Yet, any growth in the assets will be outside the estate, and it is effective immediately held in trust for the named beneficiaries (and so outside of the estate).

Discounted Gift Trusts

A discounted gift trust gives the settlor the ability to pay into a trust and then take a series of fixed withdrawals from it for the rest of their life. The original money paid into the trust will be discounted for inheritance tax purposes and after 7 years will completely fall outside the scope of inheritance tax.  Any additional funds arising due to growth on the assets inside the trust are immediately outside the estate of the settlor.

Discretionary Will Trusts

A discretionary will trust is similar to a discretionary trust.  It is written into the will of the settlor and is automatically set up when they die.  The trustees are given discretion over how the assets are distributed and all capital and income is distributed completely at their discretion.  Although the beneficiaries are established when the trust is set up and there can be several beneficiaries.  The ability to allow the trustees the power to decide how much beneficiaries get from a trust and when they get it means there’s more flexibility and assets can be protected if circumstances change for any reason.

Life Interest Will Trusts

A Life Interest Will Trust is simply a life interest trust which is included in a Will.  It is a legal entity which allows the assets belonging to the deceased to be placed within the trust for the beneficiary (often a surviving spouse)who is known as the ‘life tenant.  A life interest will trust will commence when the settlor of the trust dies. It will allow one beneficiary the right to occupy a property or take an income from the trust.  The assets in the trust will pass to the other beneficiaries upon the death of the life interest beneficiary.

Final Thoughts

When thinking about financial wellness and how estate planning may provide peace of mind, you may be looking for assurances that your hard-earned assets will be cared for in a thoughtful manner. Common strategies for this generally include creating wills or naming beneficiaries of retirement assets. It is also important to consider when and how to create a trust. Because your life is unique, you may have situations that could require special attention. If you are not ready to relinquish control, but you still want the benefits of a trust, you can appoint yourself as trustee and name a successor trustee for when you are ready.

 

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