Understanding the basics of different types of trust.

Setting up a trust can be an effective way to manage and protect assets, whether gifting for family, inheritance planning, or charitable purposes. Trusts are versatile and flexible, some allowing you to retain control over how assets are distributed and used, even after your passing. However, understanding the different types of trusts available in the UK can be challenging. Here, we provide an overview of the basics of various types of trusts, highlighting their potential uses and benefits.

What is a Trust?

A trust is a legal arrangement where one party (the settlor) transfers assets to another party (the trustee) to hold for the benefit of a third party (the beneficiary). Trusts can be used for many purposes, such as protecting family wealth, controlling how and when assets are passed to beneficiaries, and reducing inheritance tax liabilities.

There are various types of trusts available in the UK, each with unique features and applications. The most common types include bare trusts, discretionary trusts, interest in possession trusts, and charitable trusts.

1. Bare Trusts

Bare trusts are the simplest type of trust. Under a bare trust, the trustee holds the assets in their name but is legally obliged to pass the assets, known as the trust fund, to the beneficiary when they reach a specified age, typically 18 in England and Wales or 16 in Scotland.

Who is it for? Bare trusts are commonly used by parents and grandparents who want to give gifts to minors. Once the beneficiary reaches the specified age, they gain full control of the assets.

Tax Implications: In a bare trust, assets are considered as belonging to the beneficiary, so any income or capital gains are taxed as if they were the beneficiaries. For inheritance tax purposes, a gift into a bare trust is a potentially exempt transfer, meaning it will be exempt from inheritance tax if the settlor survives for seven years after the transfer.

2. Discretionary Trusts

A discretionary trust offers greater flexibility for the settlor. In this arrangement, the trustee has the authority to decide which beneficiaries receive payments and how much they receive. This flexibility allows trustees to respond to beneficiaries’ changing needs and circumstances over time.

Who is it for? Discretionary trusts are ideal for those who want to provide for future generations without giving any individual a fixed entitlement. These trusts are also commonly used by families with disabled beneficiaries or other dependents who may need ongoing support.

Tax Implications: Discretionary trusts are subject to a unique tax structure known as the “trust rate” for income and gains above a certain threshold. They are also subject to periodic inheritance tax charges, often every ten years, as well as exit charges when assets are distributed to beneficiaries.

3. Interest in Possession Trusts

An interest in possession (IIP) trust allows a beneficiary to receive income from the trust's assets, while the underlying capital remains preserved. Typically, an individual is given the right to benefit from the income for life, known as ‘life tenants’, after which the capital passes to another beneficiary.

Who is it for? IIP trusts are often used in estate planning to ensure that income can support a spouse or family member during their lifetime, while the capital is preserved for other beneficiaries, such as children.

Tax Implications: For inheritance tax purposes, an interest in possession trust may be treated as part of the estate of the beneficiary with the right to income. Additionally, income generated by the trust is typically taxed at the beneficiary’s income tax rate.

4.  Charitable Trusts

Charitable trusts are established to support charitable purposes and benefit the public. Charitable trusts have to meet specific criteria set by the Charities Act and are generally tax advantaged.

Who is it for? Charitable trusts are suited for individuals or families interested in philanthropy or wishing to create a lasting charitable legacy.

Tax Implications: Charitable trusts are often exempt from income tax, capital gains tax, and inheritance tax, providing tax-efficient ways to support charitable causes.

Setting up a Trust: Key considerations

Setting up a trust is a significant financial decision that requires careful planning and consideration. Here are some key factors to consider:

1.  Purpose of the Trust: Determine what you want to achieve. Are you planning for future generations, providing for a dependant, or supporting charitable causes?
2.  Choosing Trustees: Trustees play a crucial role, so selecting individuals or professional trustees who understand your intentions and have the expertise to manage the trust is essential.
3. Tax Implications: Each type of trust has distinct tax rules that impact both the settlor and beneficiaries. Consulting with a financial adviser or tax specialist can help you optimise the trust structure to reduce unnecessary tax liabilities.
4. Legal Advice: Trusts can be complex legal instruments, and any errors in structuring or documentation can lead to unintended tax consequences or disputes. A qualified legal adviser can help ensure the trust is legally sound and aligned with your goals.

Benefits of working with a Financial Adviser

Understanding the ins and outs of different types of trusts requires a solid grasp of both tax law and financial planning. A financial adviser who specialises in trusts can help you design a trust that meets your specific goals, while also minimising tax liabilities. Advisers can assist in selecting the most appropriate type of trust, structuring the trust assets, and providing guidance on selecting trustees.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.