Trusts in the UK: What Are They and Who Needs One?

If you’ve done any research into estate planning, you will almost certainly have come across the idea of trusts. They are often cited as a vital tool for providing for your family’s future, as well as being a helpful way to reduce inheritance tax liability.

Though trusts are spoken about a great deal, there can be a lot of confusion about what they actually are and who might need one.

What is a trust?

Essentially speaking, a trust is a legal mechanism that allows certain assets (generally money, property or other belongings) to be held in something other than a standard form of ownership. You can write a trust into your Will for your executors to set up after your death, or you can set one up yourself whenever you choose.

When an asset is held in trust, instead of it being handed outright to the new owner, it will be looked after by nominated trustees on behalf of the new owner. This involves splitting the two strands of ownership: legal ownership (the right to administer the asset), which will be held by the trustees, and equitable ownership (the right to benefit from the asset), which will be held by the beneficiaries.

There are multiple reasons why this might be beneficial. The simplest and most obvious reason to set up a trust is because you are bequeathing assets to a beneficiary under the age of 18. In matters like these, a child beneficiary would obviously be unable to hold the legal ownership of an asset such as a large sum of money or property themselves. Instead, you would typically name a trustee to look after the assets on their behalf.

The trustees would hold the legal ownership of the asset and would have the right to do things such as making payments from bank accounts or handling maintenance on a property. However, they would only be able to do this for the benefit of the beneficiary, not for their own gain.

What kinds of trusts are there?

There are many types of trust, and which type is appropriate for you will depend on your personal circumstances, intentions and wishes for the future. A solicitor who is experienced in setting up trusts will be able to advise you on the best way forward.

Below we’ve shared three of the most common types of trust, along with some of the scenarios they might be helpful for.

Bare trust

This is the simplest form of trust, whereby a trustee holds assets on behalf of a beneficiary who has an absolute right to those assets.

This is the kind of trust that is typically used to hold assets on behalf of a child under the age of 18. The trustees would handle the legal ownership and manage any necessary transactions and asset maintenance until the beneficiary turned 18 and was able to take on the legal ownership themselves.

Discretionary trust

A discretionary trust functions in a similar way to a bare trust, but with the significant difference that the beneficiaries do not have an automatic right to the assets held by the trust. Instead, in a discretionary trust, the trustees are given the power to determine how or whether to distribute assets to beneficiaries. Another difference is that beneficiaries of discretionary trusts don’t have to be specific named individuals. You can set up a discretionary trust to benefit a class of beneficiaries, such as grandchildren.

This type of trust could be useful in situations where you want to set assets aside for a group of individuals who have not been born yet (such as grandchildren or great grandchildren), or individuals who may not be able to manage the assets themselves, perhaps due to an issue such as addiction, severe mental illness or bankruptcy.

Life interest trust 

This allows an individual to give an asset to a beneficiary who can benefit from it for the duration lifetime, whilst also being able to choose who they would ultimately like to inherit the asset once that first beneficiary dies.

This is often used be people who want to give their partner the right to live in a property for the rest of their life, but still wish to ensure that the ownership of that property will ultimately pass to their children.

How can a trust help with inheritance tax planning?

Trusts are often discussed in the context of IHT planning. This is because certain trust arrangements may help to reduce the amount of inheritance tax that will come due on your estate after your death.

How a trust will affect the amount of inheritance tax that is due will depend on various factors. This includes the type and value of the assets, the form of trust that is used, and when the trust has been set up.

Some types of trust will be liable for inheritance tax payments even before your death. This may be as part of a lifetime transfer inheritance tax fee, or as part of the relevant property regime. Though it may sound counterproductive if you are trying to reduce IHT liability, paying tax on trusts in advance might ultimately reduce the overall amount of tax that is paid on your estate.

The time that the trust is set up can also be crucial. Some trust assets will be considered ‘potentially exempt transfers’. This means that the assets held in those trust will be exempt from inheritance tax, but only if you outlive the creation of the trust by seven years or more. If you were to die within seven years of setting up the trust, then the contents of the trust would be taxed along with the rest of your estate. This is why these assets are only considered ‘potentially’ exempt at the time of setting up the trust.

Seeking specialist advice

The rules in this area can be difficult to navigate without expert knowledge. We’d always advise seeking professional advice before you decide whether to make trusts a part of your plan for your estate.

If you’re interested in discussing whether or not setting up a trust could be beneficial for you, our knowledgeable solicitors are always on hand to help.