What is a Trust?
A Trust is a legal arrangement where someone known as the “Settlor” transfers the ownership of their assets to the Trust. It is the job of the Trust to administer the assets for the benefit of a third party “beneficiary / beneficiaries” as per the wishes laid out by the Settlor in the Trust deed.
These administrators are known as “Trustees”. The Trustees can either work alone or jointly with others. There is no limit to the number of Trustees a particular Trust can have (with the exception of land, where there cannot be more than 4 Trustees), but it is strongly advised that there be at least 2. The Settlor can also nominate a professional Trust company if the Trust may be complicated or if they do not wish to burden family or friends with the responsibility.
A Trust can be setup either in the Settlor(s) life time “Lifetime Trust” or upon death “Will or probate Trust”.
Why would I need a Trust?
There is a misconception that Trusts are only for the wealthy, but this is not the case. Trusts are more common than you may think, the chances are that you have already indirectly felt the benefit of one. A classic example of this is a works pension scheme. The pension scheme will have been set up as a Trust. The employer would be the Settlor, the pension fund managers are the Trustees and the employees are the beneficiaries.
Another example of this is Insurance policies. Many policies are “written in Trust” so when the insured person passes away the policy pays to a Trust rather than to the deceased. This way the money does not pass through the deceased estate and therefore is not included when working out Inheritance tax. The money is often used to pay off mortgages and or other debts.
As house prices continue to become more expensive the need for Trusts has increased. More and more people now find themselves over the £325,000 Inheritance Tax threshold. Trusts are a great way to insure that you do not pay unnecessary Inheritance Tax by ensuring you make the most of your inheritance allowance also know as Nil Rate Band (NRB).
Also, families have become more complicated. Gone are the days where people spent their lifetime with the one partner. Many people now have had children with one or more partners but they want to ensure that all their offspring still benefit upon their passing. A Trust is a fantastic way to ensure this happens.
The most common family situations where Trusts are used are:
- To provide for the surviving spouse after death whilst protecting the interests of any children.
- To ensure that young children inherit at an age where they are deemed responsible.
- To provide for those who are classed as disabled or vulnerable who are not able to take care of their own affairs.
- To help succession planning in a family business.
There are a wide range of Trusts available for all types of circumstances.
Types of Trusts
Trusts are split in to two categories Living/Lifetime Trusts
and Will/Probate Trusts
Living /Lifetime Trusts
These trusts are set up in the lifetime of the Settlor. For example the Settlor may have a potential issue with regards to inheritance tax, they may therefore decide to set up a Lifetime trust so that he can move cash out of his estate. As long as the Settlor survives for at least 7 years or more from the date of the gift to the trust then this will have deemed to have fallen out of their estate and will not be taken in to consideration for Inheritance tax purposes. These are commonly known as ‘PETs’ (P
ransfers) However, should the Settlor die within 7 years or if further gifts were made without completing a clear 7 years then the HMRC will go back further and all gifts may be liable to Inheritance tax.
Example of Lifetime Trust
Pilot Trust (Spousal-Bypass-Trust)
This trust is also known as ‘Spousal By-Pass Trust’. These are commonly used to put Death In Service (DIS) pension benefits and or Life insurance payouts into a discretionary trust with the remaining spouse or issues as the beneficiaries. By doing this it prevents the proceeds being taxed as part of the spouse’s estate for Inheritance Tax on second death.
Cost: Simple £299.00 or Complex £599.00
Home Protection Trust (HPT)
This Trust is commonly used to secure the family home for future generations. The HPT is a discretionary trust which creates an interest in possession for the Settlor. This trust is most beneficial where the owner is single, a widow or widower and other protective measures cannot be implemented.
Unlike a Will based Trust this is a tailored document which is already in place before the date of death. This also gives the benefit that there are no further fees as they have already been paid in the Settlor’s lifetime. Also, the assets under the trust will not pass under the Will of the Settlor, probate is not required to administrate these assets resulting in a reduced period of administration after death.
Asset Protection Trust (AST)
This trust is almost identical to the Home Protection Trust with the exception that other assets such as cash and business assets can also be placed in to the trust.
As far as local authorities and care fees are concerned, in theory Home/asset protection trusts can be used to indeed protect the assets although, of course, the local authority may decide that a particular individual “deliberately deprived themselves of assets for the purposes of avoiding paying for care” and, in such a case they would assess the contribution as if the Settlor still had the assets. And, of course, if assets have been transferred (whether to a trust or outright) with the intent of avoiding using them to pay for care within six months of entering a home, or while a person is in a home, the local authority has powers to recover from the person to whom the assets were given (ie., the ‘third party’) any money owed to them in respect of the original owner’s place in a home. If the asset in question is a house, the local authority can put a charge over it.
Discretionary Nil Rate Band Trust
A nil-rate band discretionary trust is a version of such a trust used in estate planning to reduce liability to Inheritance tax on the death of a surviving joint proprietor. It is commonly used in areas where residential property prices exceed the Inheritance tax threshold, with the additional aim of avoiding the need to sell the family home to meet Inheritance tax liability.
Such a trust can also be used to protect assets that are intended to go to particular beneficiaries (e.g. children from a previous relationship) in the event that the survivor remarries. It can also protect assets that otherwise could be liable to means testing if the survivor had to go into long-term care, or could be vulnerable to creditors if the survivor got into financial difficulties.
Will / Probate Trusts
Will trusts are mainly used by married couples and civil partners and are set up in conjunction with splitting ownership of the family home, to ‘tenants in common’, so each partner has 50%.
Rather than leaving this to each other, they leave it to a trust, which comes into being on the death of the first partner.
Until recently, nil-rate band will trusts were a common way of saving inheritance tax (IHT). A couple potentially liable could split their estate into halves, both below the nil-rate band.
However, since 2007 the ability to transfer unused IHT allowance ended the need to make this type of will trust for most couples, although they still ring fence assets against potential fees should you or your partner go into long-term care. They also can stop children from sideways inheritance should the surviving spouse remarry.
Protective Property Trust
This is one of the most popular trusts of all Wills written today. This type of trust is also known as a “Life Interest Trust” and is very useful for a number of reasons. If the property is jointly owned then the first thing is that the ownership is changed from Joint Tenants to Tenants in Common (Sever the Tenancy), by doing this each person then has a defined share in the property i.e. 50/50 and therefore can gift their share to whoever they wish i.e. children from a previous marriage. This must be lodged with the HM Land Registry during the testator’s lifetime. By severing the Tenancy the local authority to can only make an assessment on the share of the person that may need to go in to care and not the property as a whole.
The trust is written to allow the survivor to remain in the property for their lifetime but with the flexibility to sell and purchase another property if they need to downsize. On death of the survivor the estate is distributed as per the directions of the trust and not the Will of the survivor.
This type of trust is great for couples who may have children from previous relationships/marriages who want to provide for their current spouse but ensure that their assets pass to their children.
Cost: £850 (including Mirror Wills)
Discretionary Will Trust capped at the Nil-Rate band
This type of trust is used in mirror Wills, but is not used as much these days with the introduction of the Transferable Nil-Rate Band (TNRB), it is still a useful tool to ring fence assets for children, especially where there may be children from a previous relationships. It is also still a valuable tax planning tool where the marriage is not the clients first and the previous marriage(s) ended on death.
Flexible Lifetime Interest Trust (FLIT)
A Flexible Life Interest Trust (FLIT) offers greater peace of mind if you have significant assets or investments as well as property, and wish to protect their value for future generations.
A FLIT if often referred to as the ideal modern Will Trust, as it allows for adequate provision for the surviving spouse/partner, whilst incorporating flexibility into the Will whereby other family members/beneficiaries may benefit should the survivor not require the provision after the first death. The FLIT is flexible because it allows the Trustees to advance capital as well as income to the survivor, if required.
This Trust is created on the death of the first spouse/partner and the capital assets of the deceased are held in a trust which pays any income generated to the survivor for their lifetime. This is treated for Inheritance Tax purposes as an outright gift to the survivor. So, for married couples or those in a Civil Partnership, it does not create a tax charge and does not use any of the Inheritance Tax allowance of the deceased spouse – preserving it for later use on the death of the surviving spouse. On the death of the survivor, the trust capital is passed to nominated beneficiaries, such as children. Because the capital in the trust is not owned by the surviving spouse/partner, it cannot be given away by them to, say, a new spouse or partner, and it cannot be assessed if the survivor needs to end their days in a care home.
Disabled/Vulnerable Person Trust
This is a discretionary trust that is written in to the Will. It is designed to protect the beneficiaries should they have difficulty in managing financial affairs. Common factors are disability, a dependency on drink or drugs, gambling addiction or have a taste for excessive or extravagant spending. This trust allows the testator to provide for the client in a controlled manor. The Trustees are able to advance capital and income as required in accordance with the ‘Letter of Wishes’ prepared by the testator.
For beneficiaries who are deemed to be vulnerable but not disabled, the Trustees are able to manage the funds on behalf of that person. By doing this it removes the risk of the funds being misspent on drink and or drugs that could lead to ill health or even death.
Where the trust is for a disabled beneficiary the trust complies with S89 IHTA 1984 and therefore benefits from preferential tax treatment.
Business Asset Protection
This is for those with business interests to include Business Property Relief Trust. This ensures maximum relief from any tax advantages available at death are utilised, whilst ensuring that the spouse receives income from the business to maintain their lifestyle. The business will pass to the children or other taxable beneficiaries if eligible.
Right to Reside or Occupy
This type of trust is usually used when the property is owned by a sole person and they wish for their spouse, child, parent or any other person (the occupant) to have the right to live at the property without ever owning it. This allows the owner to state who will inherit the property when the occupant eventually dies which would not be the case if they had given the property to them absolutely. The Trust can have set conditions such as a set period of time, them attaining a certain age or other condition.
IOU Discretionary Will Trust
This over looked trust can sometimes offer considerable savings on Inheritance tax.
They work by allowing you to leave your assets to a trust rather than absolutely to your spouse. The surviving spouse may be allowed to borrow those assets from the trust on the basis that they are repaid upon death. By doing this the debts they have accumulated will be payable from the spouses estate therefore reducing the value of their own estate and in turn their Inheritance tax bill.