The Power of Planning: Understanding Trusts in Wills and Lifetime Trusts

Trusts can seem a daunting prospect to clients when considering estate planning, however, our expert team at MLP Law can help to clarify and explain in straightforward terms the pros and cons of entering into a trust arrangement, whether that be in your will or a lifetime trust.

Certainly, the taxation landscape around trusts can be a minefield so it is crucial to seek expert legal and taxation advice when considering trusts and how they can help you to plan your estate. If used correctly and at the right time, a trust can save you considerable sums in tax and also offer protection and support for your chosen beneficiaries in the long term.

A trust is a legal arrangement that can give you control over what happens to your financial assets both during your lifetime and when you die.

Trusts can protect your assets from inheritance tax and care home fees. However, different kinds of trusts have varying financial and practical implications, so the first step in setting up a trust is to seek tailored legal advice.

There are two main types of trusts you might consider: a Lifetime Trust, which you set up during your lifetime; and a Will Trust, which is created upon your death. Here we talk about the advantages and disadvantages of both.

Who are the parties in a trust?

When you set up a trust, you are known as the ‘settlor’. You will choose a third party (‘trustee’) to manage your assets for the person you wish to benefit from the trust (‘beneficiary’). You can choose more than one trustee and more than one beneficiary. Here we discuss the legal terms used to define the parties involved.

Settlor

This is the person or the company who sets up the trust. They can also be called the donor, grantor, trustor or trust-maker. The settlor makes the decision about how the assets in the trust should be used and this is set out in a legal document called a ‘trust deed’. Once the assets are in trust, the trustee—not the settlor—legally owns them (although the trustee is bound by law to make sure the beneficiaries receive the benefit of the trust). It’s important to know the trustee well before appointing them. In some kinds of trust, the settlor is also the trustee and/or the beneficiary.

Trustee

A trustee is a person or company who manages the trust’s assets for the benefit of the beneficiaries. Their duties are set out in the trust deed. Trustees must not benefit personally from their role unless they hold the trust in a professional capacity and receive a fee for their service.

It’s the trustee’s role to manage the trust prudently according to the settlor’s wishes by investing assets wisely (if applicable) and paying any taxes due. They must also keep accurate accounts and records, which are completely separate to their personal finances. Trustees can be held personally responsible for any breaches, so it’s important that they follow the advice of an experienced private client lawyer and fully understand their responsibilities.

Trustees can be removed or replaced by settlors or beneficiaries in certain circumstances, but this depends upon the type of trust and the terms of the trust itself.

Beneficiary

A beneficiary is a person who will benefit from the assets in the trust.

If the trust set up is a ‘revocable’ trust, which means the settlor can change it or revoke it at any time, the beneficiary (unless they are also the settlor) has no rights until they receive the assets from the trust. ‘Revocable’ trusts, by their very nature, must be Lifetime Trusts (see below).

If the trust is ‘irrevocable’, meaning it cannot be changed by the settlor without a court order, then the beneficiaries have certain rights before the trust is redeemed. They can make sure the trustee is acting in their interests by asking to see records and accounts. The full scope of their rights depends upon the terms of the trust.

What is a Will Trust?

A will trust or ‘testamentary trust’ is only created upon death. You set up the trust as part of your Will in order to pass assets on to your family or loved ones.

There are different types of Will Trusts.

Discretionary Trust

This trust gives the trustees the discretion to decide which of the Will’s beneficiaries to pass trust assets on to, how much they will receive, and when they will receive it. This protects a beneficiary’s money if they are financially unstable for any reason and it means money does not have to pass to a beneficiary who has become wealthy.

Property Protection Trust

A property trust helps to protect property from being used to pay for long-term care fees. For this kind of trust to work, you and your partner or spouse must own the family home in joint names as tenants in common.

Each partner sets up a Will with each of you leaving your share of the property in the property trust. When one of you passes away, that share of the property passes into trust. Then if the survivor needs long-term care in the future, only their share is used by the local authority for a means-test when calculating contributory fees, because the other share is protected in the property trust. The protected share will eventually pass to the Will beneficiaries.

Flexible Life Interest Trust

A life interest trust allows you to specify who will have the rights to your property after you die. It’s very similar to a property trust in that it offers protection from home care fees. The main difference is that a life interest trust protects all your assets and not just your property. It also enables you to choose somebody to benefit from the trust whilst they are alive and at the same time to protect the underlying capital for other beneficiaries after their death.

Your chosen beneficiaries can have access to capital sums as agreed by the trustees

What is a Lifetime Trust?

Lifetime trusts are different from Will trusts because they are established straightaway and not upon death. You may however have to pay an immediate inheritance tax charge of 20% on the value of trust assets transferred into trust and in excess of the nil rate band (currently £325,000).

Bare Trust (or Simple Trust)

Assets in a bare trust are held by a trustee until the beneficiary is 18 years old (it’s also possible to state that the beneficiary will receive these at a different age, such as 21 years). Once the beneficiary turns 18 they have the right to all the income and capital of the trust immediately. Beneficiaries are liable for Income Tax and may be liable for Capital Gains Tax. However, they are likely to be exempt from inheritance tax as a bare trust is treated as a ‘potentially exempt transfer’. This means that inheritance tax will only be payable if the settlor dies within seven years of setting up the trust.

Interest in Possession Trust

This type of trust is similar to a life interest trust (see above) except that the beneficiary can receive income from the trust as soon as the trust is set up.

Discretionary Trust

These can be established in the lifetime as well as by Will.

Settlor-Interested Trust

Settlor-interested trusts are not trusts in themselves. They are any type of trust in which the settlor, their spouse or civil partner benefits from the trust’s assets in any way.

For example, if Fred has an illness and can no longer work then he might decide to set up a trust. Fred is the settlor of the trust and the trustees make payments to him. Since he receives benefits from the trust he ‘retains an interest’.

The settlor is liable for income tax on all payments made by the trustees and may also be liable for Capital Gains Tax. When the settlor dies, inheritance tax will be payable above the £325,000 tax-free threshold.

Vulnerable Beneficiary Trust (or Disabled Trust)

These trusts are set up for beneficiaries who have a mental or physical disability or who are under 18 years of age and have lost a parent. Vulnerable beneficiary trusts can claim ‘special tax treatment’ as long as the beneficiary qualifies under HMRC rules and the circumstances of the trust allow. Broadly speaking, ‘special tax treatment’ aims to tax the beneficiary’s proportion of the trust as if their usual rates, reliefs, and allowances are applied so that they gain maximum financial benefit.

Assets of other beneficiaries of the trust who are not classed as vulnerable must be kept separate for tax purposes.

When planning your estate, you want to make sure the people you choose will inherit your assets according to your wishes, that you minimise inheritance tax losses, and that your entire property isn’t lost to home care costs. Trusts can achieve your aims, but it’s important to select the right one for your particular needs and circumstances.

A trust can be set up at any time or written into your Will. At MLP Law Ltd our specialist trust and Will, solicitors are here to help you protect your assets both now and in the future. Call us on 0161 926 1538 to discuss your options and how we can help.