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Trusts

19/05/2023

A trust is a legal arrangement for managing assets. Trusts can come into creation as an ‘implied trust’ (generally not deliberately created and typically arising by operation of law) or as an ‘express trust’ (deliberately created) – in most instances, a trust will be an express trust. 

In a trust, the person who provides the assets is called the settlor (or testator if created under a Will). The trustees are the people who hold and manage the trust assets, which they do for the benefit of the trust beneficiary/beneficiaries.

Types of Trust

There are many different types of trust. Trusts can also be classed under different labels for different purposes and have been adapted to achieve different aims. This can cause confusion and make the subject complicated. However, some of the most common types of trust are as follows: 

  • Bare, Absolute and Fixed trusts – These are relatively simple trusts, where the beneficiary’s or beneficiaries entitlement is fixed at outset. Assets are held in the trustee’s name but the beneficiary has the right to the trust property once 18 or over (in England and Wales), or 16 or over (in Scotland). These are often used to pass assets to young or disabled people – trustees look after them until the beneficiary is old enough or needs them.
  • Discretionary trusts – This is where the trustees have complete control over the assets and the income generated, deciding how and when to give them to the classes of beneficiary outlined in the trust deed. These are often used to pass money and assets to children and grandchildren as and when it is needed.
  • Interest in possession trusts – Where beneficiaries are entitled to all income from the trust straight away but do not control the assets that provide the income. The beneficiary has to pay income tax on the money they receive. It’s common for a settlor to give their partner access to this kind of trust in their lifetime, with any assets passing to the settlor’s children after their partner dies.
  • Trust for a vulnerable person – Where the only beneficiary is vulnerable (for example someone who is disabled or an orphan). This allows for less tax to be paid on the income from the trust.
  • Mixed trusts – Where elements from different trusts are combined. For example, it might give the beneficiary a right to the income (called an interest in possession) of half of a trust fund.
  • Settlor-interested trusts - Where the settlor or their spouse/civil partner can benefit from the trust.   

Other trusts used for financial planning

Other types of trust that are commonly used in financial planning include:

  • Flexible Trusts (also known as a ‘Power of Appointment’ trust) – A type of discretionary trust, where default beneficiaries can be named, but trustees retain the power to vary or appoint new beneficiaries. The trustees have the power to replace an actual beneficiary with anyone from the list of potential beneficiaries.
  • Loan Trust – Where the settlor loans money to the trustees for investment, usually interest free. Used for estate planning, as investment growth on the loan is outside the settlor’s estate and the loan can be waived in part or full later on.  
  • Discounted Gift Trust – Where the settlor gifts assets to the trust with a caveat that in return, the trustees pay the settlor a regular income. The right to the income is valued and deducted from the gift for inheritance tax purposes (where the settlor dies within the first seven years or the gift is a chargeable lifetime transfer exceeding the £325,000 nil rate band).  
  • By-Pass Trust – A generic term for a discretionary trust that is set up to receive pension lump sum death benefits. It is named as such because it allows the pension to be paid to the trust, thereby bypassing the spouse (although the spouse will still be a potential trust beneficiary). It is normally used in complicated family situations, often where the settlor has remarried and has children from an earlier marriage. It will normally be set up as a pilot trust initially.
  • Pilot Trust – Set up with a small sum of money (i.e. £10) with the intention of receiving a larger sum at a later date (such as death in service benefits or pension funds on death).
  • Will Trust – A trust that is set up within someone’s Will and comes into effect on their death.

Taxation of trusts

The tax incurred by a trust can be complicated and will differ depending on the type of trust used. However, a high-level overview of the main taxes is as follows:

Event

What

Type of Trust

Rate of Tax

Assets gifted to Trust

Potentially Exempt Transfer (PET)

Simple trusts (i.e. bare, absolute and fixed trusts), where the beneficiaries are set at outset

1. Tax free if settlor survives 7 years.
2. Otherwise Inheritance Tax (IHT) on amount above nil-rate band, subject to taper relief.

Chargeable Lifetime Transfer (CLT)

Most other trusts, where the trustees have some discretion over beneficiaries

1. Inheritance Tax (IHT) at half rate (20%) once nil rate band exceeded.
2. Further IHT due on settlor's death within 7 years, subject to taper relief.

Trust income Received

Income Tax

Simple trusts (i.e. bare, absolute and fixed trusts), where the beneficiaries are set at outset

Taxed at beneficiary's marginal rate

Interest in possession trusts

Dividend-type income 8.75%
All other income 20%

Most other trusts, where the trustees have some discretion over beneficiaries

1. Trust income up to £1,000*
Dividend-type income 8.75%
All other income 20%
2. Trust income over £1,000
Dividend-type income 39.35%
All other income 45%
* If settlor has more than one trust, £1,000 band is spread across trusts, subject to a £200 minimum per trust.

Capital Gain Realised

Capital Gains Tax

Simple trusts (i.e. bare, absolute and fixed trusts), where the beneficiaries are set at outset

Taxed as beneficiary's capital gain.

Where the beneficiary is vulnerable - a disabled person or a child whose parent has died

Taxed as beneficiary's capital gain.

Most other trusts, where the trustees have some discretion over beneficiaries

1. Entitled to an Annual Exempt Amount (AEA) of half that allowed to individuals (£3,000 for 2023/24 and £1,500 for 2024/25 onwards).
2. Pay higher rate of tax on all gains after AEA (28% on residential property or 20% on other chargeable assets).

10 year anniversary

10-yearly Inheritance Tax Charges

Most trusts where the trustees have some discretion over beneficiaries

Maximum of 6% on assets - complicated calculation required to determine amount of tax payable. HMRC will calculate on trustees behalf (via IHT100 form)

When assets are transferred out of a trust or trust ends

Inheritance Tax Exit Charges

Most trusts where the trustees have some discretion over beneficiaries

Maximum of 6% on assets - complicated calculation required to determine amount of tax payable. HMRC will calculate on trustees behalf (via IHT100 form)

 

Comment 

Trusts can be complicated, with various terms often used interchangeably. However, they provide a valuable way to protect assets and ensure financial stability for someone’s loved ones over time. 
For a bespoke trust, assistance from a Solicitor will normally be required to draft the trust deed and rules. Alternatively, many providers do offer suitable draft trust deeds that can be used by advisers to set up trusts that clients can use for investing in their products.

Remember that since 1 September 2022, most express trusts will need to register on the Trust Registration Service (TRS). Furthermore, there is a legal requirement for evidence of registration to be provided before firms can enter into a business relationship with the trust.  

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.