What exactly is a trust

A trust is where assets are formally transferred into a legally binding arrangement to be held and managed for the benefit of another party. 

A standard trust has three core parties:

• The Settlor – The person who creates the trust and transfers assets (such as cash, investments, or property) into it. The settlor will define how the trust is set up and what the rules of the trust are, which will be set out in the trust deed.

• The Trustees – The individuals or entities appointed to manage the trust. These are the legal owners of the trust’s assets and are responsible for safeguarding them, reporting any tax liabilities, and managing the assets in accordance with the trust deed.

There should normally be at least two trustees, and the settlor will often decide to be a trustee themselves.

• The Beneficiaries – These may be individuals, defined groups, or charities who can benefit from the trust. Beneficiaries will be entitled to the trust income and/or the trust capital. Who can benefit and at what point will be set out in the trust deed and rules.

A trustee can potentially be a beneficiary of the trust, but normally the settlor cannot. If the settlor is a potential beneficiary of a trust, it can trigger the ‘gift with reservation’ rules, which typically makes a trust very inefficient for tax purposes.

The three certainties (the legal foundation)

For a trust to be legally valid, what is known as the ‘three certainties’ must be satisfied. If any of these three elements is missing from a trust, it will automatically fail.

• Certainty of intention – It must be clear that the settlor intended to create the trust.
• Certainty of subject matter (property) – The assets placed into the trust must be explicitly identifiable. It must be clear exactly what has been placed into the trust.
• Certainty of object (beneficiary/ies) – The beneficiaries of the trust must be clearly defined or identifiable. This could mean named individuals or clearly identifiable classes of beneficiaries (for instance ‘my children and grandchildren’).

Types of trust

In the UK, there are many different types of trust. However, some of the main types of trust are as follows:  

• Bare trusts (sometimes called ‘absolute’ or ‘fixed’ trusts) – this is a relatively simple trust. Assets are held in the name of the trustee, but named beneficiaries have the right to all the trust property as long as they’re 18 or over (in England and Wales) or 16 or over (in Scotland). 

These are often used to pass assets to young people – trustees will look after them until a beneficiary is old enough to do so themself.

• Discretionary trusts – Here, trustees have complete control over the assets and the income generated, with flexibility to decide how and when to give them to beneficiaries. Potential beneficiaries have no rights to ownership of trust property, with trustees selecting from a range of eligible individuals or groups (classes) named in the trust deed and rules.  
• Interest in possession trusts – Where one beneficiary is entitled to all income generated from a trust, with the capital preserved for different beneficiaries.

Interest in possession trusts are commonly used to provide a surviving spouse/partner with income in their lifetime, whilst preserving the assets for the settlor’s children when they die.

• Mixed trusts – This combines elements from different trusts. For example, it might give the beneficiary a right to the income (an interest in possession) of half of a trust fund.

Technical commentary

In financial planning, trusts can take many forms and go by different names. For instance, a ‘Will trust’ comes into effect on death, whilst ‘trusts for vulnerable beneficiaries’ are able to claim special tax treatment.

In estate planning, loan trusts, discounted gift trusts, and reversionary interest trusts are becoming increasingly popular ways to reduce inheritance tax, whilst granting the settlor some retained access to their money.

In terms of registration requirements on the Trust Registration Service (TRS), HMRC define most trusts as ‘express trusts’, with very few exempt from registration.

However, despite the wide (and sometimes confusing) variety of names and differences, the foundation of most trusts used in financial planning can be broadly categorised into bare trusts, discretionary trusts, or income in possession trusts.

Important information

Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.