Trusts

Most people think of trusts as something the super-rich use to hide assets offshore or to give money or property to their children or grandchildren. The legend is that the trust fund is the preferred means of financing the lifestyle of the international playboy, with his mega-yacht and luxurious bolt-hole in Monaco.

However, a trust may be used for a variety of reasons but usually for tax planning to make provision for beneficiaries when you do not wish for money and property to be placed in their hands for reasons such as age, irresponsibility or disability.

In its simplest form, a trust is just a legal mechanism for separating the ownership of an asset into two parts: the "legal" ownership, or title to the asset, on the one hand, and the "beneficial" ownership on the other hand. An example of this kind of trust might be a nominee arrangement for an online stockbroker account, where the stockbroker acts as the registered holder of the shares. The stockbroker does not hold the shares for itself, but purely for the benefit of the customer, who is the "beneficial owner" of the shares.

The use of trusts is widespread and despite some recent adverse changes in tax law they remain an important tool for estate planners.

Trusts that people use for estate planning typically involve three sets of parties:

    • the settlor
    • the trustees
    • the beneficiary or beneficiaries

The trust is created when (i) the settlor transfers assets to (ii) the trustees, who hold the assets in trust for (iii) the beneficiaries.

This arrangement is sometimes called a "settlement" (say, for instance, the "Jones Family Settlement"), since the settlor is said to have "settled" assets onto the trust.

Why create a trust?

The main reason a person would put assets into a trust rather than make an outright gift is that trusts offer far more flexibility than outright gifts. Rather than giving a capital sum of money to children either during lifetime or on death, a trust could be implemented to provide that when each child turns 21, they receive a pro rata share of the capital, rather than all the capital outright.

There are countless variations on the trust theme. A grandfather whose children may produce more grandchildren could set up a trust for the benefit of both his living and potential grandchildren. The owner of a little-used seaside bungalow might wish to use a trust to give an elderly friend a "life interest" in the home, but then have the bungalow revert to the homeowner's daughter after the friend's death. Those are things that would be difficult or impossible to achieve with outright gifts.

Living and testamentary trusts

A person can create a trust while alive or upon death (or, indeed, he can do both). For most people, a trust created on death will be most relevant, particularly since changes to UK tax law over the past few years have made lifetime trusts much less attractive than they once were. Although please read our page on Pilot Trusts. (Put a link here to the Pilot Trusts page)

When a person creates a living trust, he typically does so by signing a deed of trust, in which he specifies the assets he is transferring to the trust, appoints the trustees (who typically sign the deed as well, and accept their appointment), sets out the terms of the trust, and names or describes the beneficiaries.

If a person wants to create a testamentary trust upon death, she would generally provide for it in her will. As above, this would specify the assets that are to be settled on the trust, name the trustees, set out the terms of the trust and name or describe the beneficiaries.

Duration of a trust

To avoid assets being tied up in trust indefinitely the legal system has always placed limits on the duration of trusts. Traditionally, such limits (which lawyers call "the rule against perpetuities") have been imposed by a somewhat arcane and confusing formula -- you may have heard the phrase "21 years and a life in being."

In recent years, however, Parliament has enacted statutory provisions that put limits on the duration of trusts that are simply expressed as a specific number of years. The latest, the Perpetuities and Accumulations Act 2009, provides that the duration of trusts executed after 6 April 2010 may not exceed 125 years. (NB. The prior statutory limit on the duration of a trust was 80 years).

Some trusts of course, most notably charitable trusts, may last indefinitely if this was the intent of the settlor of the trust.

Trustees

The powers and duties of trustees are usually set out in the will, deed of trust or other document creating the trust. In addition, there is a substantial body of law -- both statutory law and case law -- that governs the powers and duties of trustees.

An individual or a company can serve as a trustee. Often, for family trusts, the trustees are a combination of individual family members and professional trustees, such as a solicitor or a trust company.

For non-professional trustees, professional advice is often essential to avoid being in breach of trust and incurring personal liability to trust beneficiaries if their interests are harmed.

Tax advice

Aside from the durational limit and trustee rules discussed above, trust law imposes few restrictions on what an individual can do with a trust, so there is plenty of scope for creativity. Tax law, however, hems this in considerably, and no one should create a trust without a thorough understanding of the tax consequences. Even a small misstep can be very costly!

As a result of the 2006 Budget, a person may incur substantial and immediate inheritance tax liability if they make a gift via a living trust. Anyone thinking of doing this should proceed with great caution -- and good legal and tax advice.

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