3.2 - Trusts

Trusts

Trusts involve moving legal ownership and control of assets to a third party (trustee).

Reasons for Creating a Trust

  • Beneficiary incapable: Too young, mentally incapable, or unskilled in managing assets.
  • On death: To pass assets into a trust for named beneficiaries.
  • Tax management.

Trust Creation

  • By Deed: A trust deed, a legal contract.
  • By Will: Assets passed into a trust on death.
  • By Statute:
    • Intestacy: When there's no valid will, assets are put in trust until an administrator is appointed.
    • Joint Tenancy: Where multiple people own 100% of an asset; a trust can divide ownership.

Parties to a Trust

Scenario

Portfolio of securities (shares and bonds) worth £500,000£500,000, generating income that is reinvested. Setting up a trust for a young son to protect assets, avoid inheritance tax, and provide for his future.

Parties
  • Settler: The person who sets up the trust and relinquishes assets.
  • Trustee:
    • Takes legal ownership of assets.
    • Owes a duty of care, managing assets as if for their own benefit.
    • Must have the capacity to contract (sui juris: over 18 and of sound mind).
    • Duties include complying with the terms of the trust deed.
    • Guided by the Trustee Act on handling assets.
  • Beneficiary:
    • The person who benefits from the trust.
    • Can be named or defined by class (e.g., "all my children in equal share," "my grandchildren").
    • Can have:
      • Absolute vested interest
      • Life interest
      • Reversionary interest (remainder men)
  • Protector:
    • Oversees the trustee (typically used for offshore trusts).
    • Can be reactive (intervenes only if something is wrong) or proactive (continually guides the trustee).

Types of Trusts

Bare Trust (Absolute Trust)
  • Trustee acts as a nominee only, having no real control over asset distribution.
  • Beneficiary gains absolute vested interest at 18 and the trustee obeys their instructions
Interest in Possession Trust (Life Interest Trust)
  • Two types of beneficiary:
    • Life Tenant (Life Interest): Receives income from the assets for life but cannot liquidate the capital.
    • Remainder Man (Reversionary Interest): Receives the remaining assets after the life interest ends.
  • Example: Income from a securities portfolio goes to a spouse for life, then the portfolio is passed to the son.
  • Often used with property, where the life interest has the right to reside in the property but cannot sell it.
Powers of Appointment (Flexible Trust)
  • Trustees have control over the appointment of beneficiaries from a defined class.
  • Example: Naming grandchildren as beneficiaries as they come along.
  • Commonly used for life assurance policies written in trust to avoid inheritance tax; the policy pays out a lump sum on death outside of the estate.
Discretionary Trust
  • Trustees have powers of appointment plus absolute discretion to distribute income to beneficiaries, guided by the trust deed.
  • Example: Income used for a son's education, with the trustee deciding what qualifies as educational expenses.
  • Advantage: Flexibility, as all conditions don't need to be written down.
  • Commonly used for people with learning difficulties, those lacking mental capacity, or spendthrift beneficiaries.
Accumulation and Maintenance Trust
  • Age increased to 25.
  • Income can be distributed for the maintenance of the beneficiary (food, accommodation).
  • The rest of the income is accumulated.
  • Typically, most people will now open a discretionary trust.
  • The accumulation and maintenance trust no longer permitted.
Charitable Trusts
  • Qualify for preferential tax treatment (e.g., no capital gains tax, income tax, or stamp duty).
  • Typically, the only tax a charity would be liable for is VAT - 20%20\%.
  • Must be a bona fide charity providing specified benefits to society (e.g., education, emergency aid, sporting opportunities).