How trusts work
A trust is a legal agreement established by an individual or company (the settlor) with the intent of passing on assets to another person or group of people (the beneficiary). Within this agreement, set people (the trustees) are appointed by the settlor to manage and control the assets in the trust.
There are three roles within a trust:
Settlor – The person who establishes the trust. As the settlor, you can dictate the conditions surrounding the trust, how it shall be managed, and how and when the beneficiary receives a benefit from the trust. For example, you could specify that the assets cannot be accessed by the beneficiary until they reach 21 years old.
Trustee – A person appointed to manage and control any assets in the trust (e.g. property, investments and money) on behalf of the settlor’s chosen beneficiary until they meet the conditions of the agreement and can take ownership of the assets. The settlor can also act as a trustee if desired.
Beneficiary – A person or group of people who can receive assets from the trust. Recipients are often family members or friends of the settlor, but can include any person, charity or organisation.
Benefits of trusts
It is a common misconception that trusts are only beneficial to the extremely wealthy. In fact, trusts have potential benefits for a wide range of people. If you are considering setting one up, a trust could help you to:
- Protect your wealth and assets – The main reason people set up trusts is to protect their wealth. The protection a trust can offer you is multi-faceted.
- Avoid probate – Any assets you put into a trust no longer belong to you in the eyes of the law, which means they avoid probate (the legal process of going through your will). In the UK, this means that assets within a trust can be dealt with immediately after you pass away rather than waiting for probate. It can often take many months to obtain probate.
- Reduce Inheritance Tax – Assets held in trust may not form part of your estate when you die, which could save Inheritance Tax.
- Control the future distribution of your wealth – A trust gives you full control over who receives your assets and when. This can be especially useful if you have a complicated family situation where wealth needs to be distributed carefully or if you have concerns over a beneficiary managing a large lump sum responsibly. This can include situations where there are children from a previous relationship who need to be provided for.
- Prevent disputes down the line – While it is not impossible to challenge the terms of a trust, disputes over trusts are much less common than disputes relating to wills. Setting up a trust with support from a professional can be a very effective way of making sure your wishes are followed after you die.
- Benefit from tax relief – Some trusts have additional benefits from a tax perspective, but this depends on the type of trust. Seeking advice from a tax specialist can help you understand which trust type is best suited to your needs.
- Safeguard your assets for young or vulnerable beneficiaries – If the person you wish to receive the assets is currently too young or vulnerable to manage the money themselves, a trust can ensure your assets are protected until your beneficiary is ready to accept them as per any conditions specified.
To ensure you can access the benefits appropriate to your situation, it is essential to speak to a tax professional who specialises in trusts before you set up a trust. A trust deed must be drafted correctly to be fully effective. Contact PKF Smith Cooper to speak to one of our Private Client team today.
How trusts are taxed
Taxation on trusts can quickly become complicated and the specifics will largely depend on the type of trust you set up. In the UK, most trusts do not have to pay Income Tax on generated income until it passes a certain threshold (currently £500).
If trust assets are sold or transferred by trustees on behalf of a beneficiary, these transactions are likely to be subject to Capital Gains Tax. This does not apply to assets from bare trusts being passed to beneficiaries.
When it comes to whether a trust is subject to Inheritance Tax, there are several scenarios where a trust may be subject to Inheritance Tax, including:
- When assets are first transferred into a trust
- 10-year anniversary Inheritance Tax charges
- When assets are transferred out of a trust
- When the trust ends
- When a settlor dies and the trust is tied up in their estate.
Trustees are legally responsible for paying Income Tax, Capital Gains Tax, Inheritance Tax and any additional taxes that apply to the trust as required. It is therefore important that they understand their legal obligations to the trust and how trusts are taxed.
What are the different types of trust?
There are many different types of trust, including highly specialised trusts that can be tailored to your needs.
The four main trust types are: bare trusts, interest in possession trusts, discretionary trusts, and trusts for vulnerable beneficiaries. Each trust has different tax implications, making it vital to consult a specialist before establishing one.
Establish the right trust for you and protect your assets with PKF Smith Cooper
Our Private Client team can advise you on whether a trust aligns with your financial needs and which is the most suitable type, as well as support you in setting up and managing the trust for the benefit of your beneficiaries. Contact us today to find out more.
