I was chatting to some advisers at a conference recently when the conversation moved on to trusts. Almost all of them expressed the view that trusts are difficult to understand and as a result not always fully discussed with clients.
Truth is, there are a lot of different types of trusts – all with different tax implications. So it is worth spending some time getting a fully comprehensive understanding of how different trusts work, and the benefits they offer, before setting one up.
I hope this article will explain some of the jargon and make this complex subject easier to understand.
What is a trust?
Think of a trust as a legal safety deposit box. It is a place where you can put an asset and protect it so that someone else (often a loved one) can come along in the future, unlock the box and use the asset.
However, there are so many safety deposit boxes out there; some with keys, others with combinations. And the rules about who can unlock yours and make use of the asset depend on which type of safety deposit box you choose.
That is the way I like to picture what a trust is and explain it to the uninitiated. Of course, it is important to be aware of the more technical and legal information that defines what a trust is.
How trusts work
An individual (known as the settlor) sets up a trust, which is a legal entity, and in so doing allows another person or people (the beneficiaries) to benefit from an asset without being that asset’s legal owner.
People are chosen to manage the trust (the trustees) on behalf of the beneficiaries.
A trust continues to protect the settlor’s assets after their death or if they lose the capacity to manage their own affairs.
What is the difference between a ‘will trust’ and a ‘lifetime trust’?
Very simply, a will trust is created within a will, with the intention of protecting property to pass on to beneficiaries after the settlor has died. It is activated when the settlor dies.
Conversely, a lifetime trust is created and comes into effect during the settlor’s lifetime.
Why do people opt to use trusts?
There are many reasons why people use trusts. A trust can help ensure that your client’s family get the most out of their assets.
Some of the main reasons people use trusts are to:
- Protect assets for beneficiaries who cannot look after the assets themselves.
- Protect assets from divorcing spouses or business creditors.
- Protect beneficiaries’ entitlement to state benefits where an inheritance may compromise this.
- Provide for children who are under 18 in an income tax-efficient way.
- Ensure that a current spouse, and children from a previous relationship, are all cared for.
- Reduce inheritance tax.
- Protect family assets from the impact of care fees.
- Avoid waiting for probate before some assets are distributed.
How can someone maintain control of the trust?
A trust can be set up so that a client keeps control over the assets placed in it. This will usually be by acting as a trustee, but might also be stated under the terms of the trust.
By establishing a trust under a will, the client can also ensure that their assets are passed to the right people at the right time, after they die.
A common example is when somebody marries for the second time but has children from their first marriage. Usually, they want to ensure their second spouse is taken care of for the rest of their life, after which the money will pass to their children from the first marriage.
