To a lot of people the concept of a trust carries an air of mystery.
According to our (Canada Life) IHT survey* trusts were the second most unpopular estate planning tool, with 40% saying they had no intention of using them. 19% said setting up a trust was too time consuming or complicated when, in reality, it is a straightforward inheritance tax planning strategy and presents an opportunity for advisers to discuss this with their clients.
So, what exactly is a trust? It's a way of arranging property for the benefit of other people without giving them full control over it. An individual, referred to as a settlor, sets up a trust and puts assets (for example, cash, stocks and shares, or investment bonds) into the trust – known as ‘settling’ property. Although assets are added to the trust when it is set up, the settlor can also add assets at a later date. But care should be taken before adding new assets to an existing trust.
Within the trust deed the settlor should appoint ‘trustees’ - these may be individuals (the settlor can be one if they want), or companies acting as professional trustees. On their appointment the trustees take over the legal ownership of the trust property and are the people or entity responsible for managing the assets the settlor has transferred into the trust. They cannot use it as their own personal property; they must use it for the benefit of the beneficiaries.
Beneficiaries are the people or entities that receive the benefit from the property within the trust. They might benefit from the income from the underlying investments or property or they may benefit from the capital, such as an investment bond, or be able to benefit from both.
In every trust there is this division of property – legal title is held by the trustees and beneficial title is held by the beneficiaries.
Trustees can either be a professional such as a lawyer or a trust corporation or non-professional like a family member. But the duties are the same. Trustees have the task of managing the trust on a day-to-day basis, paying any tax that may become due, and deciding how the assets should be invested.
Any person can act as a trustee, provided that they are over the age of 18 and have full mental capacity. By appointing a trust corporation you have the added advantage that, unlike an individual, it cannot die. However, the flip side is that they will charge for their services and these fees will be paid from trust assets, reducing the money available to the beneficiaries.
The job of the trustees is to hold the trust property and administer it for the beneficiaries, as directed in the trust provisions. They must make sure that everything they do with the trust property is done for the benefit of the beneficiaries and is authorised by the terms of the trust. The trust deed will usually give the trustees specific powers to deal with the trust property.
If any monies come into the trust, the trustees have a duty to invest it, unless it is being paid out to a beneficiary straight away. Any investment must be authorised by the trust deed and most deeds now contain wide powers of investment. However, if the deed has no specific investment powers then the investment is governed by the Trustee Act 2000 (England & Wales only). The act provides the trustees with the ability to make exactly the same type of investment as if they were the outright owners of the trust's assets.
So, the trustees hold the legal title, while the beneficiaries can hold the beneficial title in a variety of ways.
Where a beneficiary holds an absolute interest in the trust asset, which cannot be taken away without their consent, on their death the value of their beneficial interest will become part of their estate to be dealt with either by their will or the rules of intestacy. It also means that provided the beneficiary is of full age (18 years in England and Wales, 16 years in Scotland) and of sound mind they can demand that the trust is wound up, in respect of the property, from the trustees.
A beneficiary that is entitled to the income from the trust property for life but cannot receive capital has a life interest. Such a beneficiary is called a life tenant (a ‘liferenter’ in Scotland). After a life tenant dies, the property passes to the next beneficiaries who are called remaindermen. The remaindermen only get a full interest after the death of the life tenant; until then their interest is known as a reversionary interest.
Where the beneficiary’s interest is dependent upon a particular event, that beneficiary is deemed to have a contingent interest. An example of a contingent interest is, ‘In trust for the benefit of ‘X’ upon attaining the age of 25’.
Holding the beneficial title to the trust asset gives the beneficiaries certain rights, which can include the right to know that they are beneficiaries, the right to see trust documentation, including the trust deed itself, and the right to see the trust’s financial records.
Trusts are set up for a variety of reasons. Some can prevent young people from getting their hands on assets before the settlor thinks they are ready, other trusts can remove property and investments from the settlor’s estate for inheritance tax purposes.
Choosing the right one is crucial and this is where seeking professional advice is beneficial. However our survey last autumn revealed that just 27% of wealthy Brits over the age of 45 have sought advice and therefore many potential clients do not understand the value of financial advice.
People believe that the main reason for using a trust is to mitigate or eliminate inheritance tax. Simply put, assets that are placed into trusts are given to the beneficiaries and are no longer part of the settlor's estate, provided the settlor survived seven years.
Whilst trusts can be used to mitigate inheritance tax they can also be used to:
- protect the assets an individual has built up, during their lifetime, from being eroded paying for care home fees in later life, provided the assets were not placed in the trust to avoid a care fees charge which would run the risk of triggering the deprivation rules.
- Within the trust the settlor can express who the beneficiaries are and under some trusts place restrictions on when those beneficiaries can receive the trust assets. If the asset was not placed in trust and the settlor died intestate the distribution may be contrary to the deceased’s intention. By using suitable trust wordings the settlor can ensure, for example that a child does not receive the money until a certain age.
- Trusts are a great way to help protect settlors’ loved ones, ensuring they can be provided for in the future. When assets are placed in trust on death they do not form part of their estate, making sure they are readily available for the trustees to continue to provide for the settlor’s loved ones. This can be particularly valuable where there are children from a previous marriage.
A trust is a useful estate planning tool. However like every such tool it has its own tax benefits and drawbacks, and as advisers you will play an important role in helping your clients work out if it is right for them.
* Survey of 1,000 UK consumers aged 45 or over with total assets exceeding the individual inheritance tax threshold (nil rate band) of £325,000. Carried out in September 2016.