Understanding Trusts: Their Types and Use in Wealth Transfer Planning

Trusts are powerful tools, pivotal in effective wealth management and transfer planning. They provide a framework for preserving and managing wealth, often mitigating tax liabilities and ensuring seamless transfer of assets. In the UK, trusts play a crucial role in financial planning. Let’s delve into the different types of trusts and explore how each can be optimally utilised in wealth transfer planning.

What is a Trust?

At its core, a trust is a legal arrangement where one party, the settlor, transfers assets to another party, the trustee, to hold for the benefit of a third party, the beneficiary. The settlor entrusts the trustee with the responsibility of managing these assets in the beneficiary’s best interest.

Types of Trusts

There are several types of trusts, each with distinct features and purposes. The most common ones are:

• Bare Trusts: Assets in a bare trust are held in the trustee’s name but the beneficiary has the right to the assets and the income they generate. This type of trust is often used for gifts to minors who can’t legally manage their own assets until they reach the age of 18 (or 16 in Scotland).
• Interest in Possession Trusts: Here, the beneficiary has an immediate right to the income from the trust as it arises, but not necessarily to the trust’s assets. The assets might be passed to other beneficiaries at a later time. These trusts are often set up to provide income for a spouse while preserving the capital for children.
• Discretionary Trusts: The trustees have complete discretion over how the assets and income of the trust are distributed among the beneficiaries. These trusts are commonly used when the settlor wants to retain control over the assets and may wish to make changes in the future.
• Accumulation Trusts: These trusts allow the trustees to accumulate income within the trust and add it to the trust’s capital. They can also pay income out, as with a discretionary trust. These trusts are often used for beneficiaries who are minors or those who aren’t capable of managing the money themselves.

• Mixed Trusts: These are a combination of more than one type of trust. The different parts of the trust are treated according to the tax rules for each type of trust. This trust type offers flexibility to the settlor to tailor the trust to meet specific needs.

The Role of Trusts in Wealth Transfer Planning

Trusts serve multiple purposes in wealth transfer planning. Here’s how:

• Control Over Asset Distribution: Trusts offer the settlor control over how and when their assets are distributed. This can be particularly useful if the beneficiaries are minors, or if the settlor wishes to stipulate certain conditions for asset distribution.
• Tax Efficiency: Trusts can be structured to minimise estate and inheritance tax liabilities. They can allow for the transfer of assets to beneficiaries in a tax-efficient manner, preserving more of the settlor’s wealth.
• Protection of Assets: Trusts can protect assets in the event of bankruptcy or divorce. They can also safeguard the interests of beneficiaries who may not be able to manage their own affairs.
• Preservation of Family Wealth: Trusts can ensure that wealth is retained within the family, for example, by specifying that assets should pass to direct descendants only.

Bare Trusts

Bare trusts are where assets are held in the name of a trustee, but the beneficiary has the right to all of the capital and income of the trust at any time if they’re 18 or over (in England and Wales), or 16 or over (in Scotland). The assets set aside by the settlor will always go directly to the intended beneficiary. Bare trusts are often used to pass assets to young people – the trustees look after them until the beneficiary is old enough​¹​.

Tax Implications: If you’re the beneficiary of a bare trust you’re responsible for paying tax on income from it. You need to tell HMRC about the income on a Self Assessment tax return​²​.

Wealth Transfer: Bare trusts can be useful for transferring wealth to minors, with the trustees managing the assets until the beneficiaries reach legal age.

Interest in Possession Trusts

Interest in possession trusts are trusts where the trustee must pass on all trust income to the beneficiary as it arises (less any expenses)​³​.

Tax Implications: The trustees are responsible for paying Income Tax at the standard rate. Sometimes the trustees ‘mandate’ income to the beneficiary. This means it goes to them directly instead of being passed through the trustees. If this happens, the beneficiary needs to include this on their Self Assessment tax return and pay tax on it​⁴​.

Wealth Transfer: These trusts can be useful when you want to provide income for a beneficiary during their lifetime while preserving the capital for future generations.

Discretionary Trusts

Discretionary trusts are where the trustees can make certain decisions about how to use the trust income, and sometimes the capital. Depending on the trust deed, trustees can decide what gets paid out (income or capital), which beneficiary to make payments to, how often payments are made, and any conditions to impose on the beneficiaries​⁵​.

Tax Implications: Trustees are responsible for paying tax on income received by discretionary trusts. The first £1,000 is taxed at the standard rate. Trust income over £1,000 has different tax rates for dividend-type income and all other income​⁶​.

Wealth Transfer: Discretionary trusts are often set up to put assets aside for a future need, like a grandchild who may need more financial help than other beneficiaries at some point in their life, or beneficiaries who are not capable or responsible enough to deal with money themselves.

The rest of the types of trusts such as Accumulation Trusts, Mixed Trusts, Settlor-Interested Trusts, and Non-Resident Trusts will follow a similar format, with an explanation of the type of trust, its tax implications, and how it can be used for wealth transfer planning.

Note: The detailed strategies for wealth transfer using these trusts are not provided due to the limited accessible resources. You may consider consulting with a financial advisor or tax expert for in-depth strategies tailored to specific financial situations.

Accumulation Trusts

Accumulation trusts are where the trustees can accumulate income within the trust and add it to the trust’s capital. They may also be able to pay income out, as with discretionary trusts​¹.

Tax Implications: The tax implications are similar to discretionary trusts. Trustees are responsible for paying tax on income received by the trust. The first £1,000 is taxed at the standard rate. Trust income over £1,000 is taxed at different rates for dividend-type income and all other income​²​.

Wealth Transfer: Accumulation trusts can be beneficial when you want to accumulate income within the trust for future distribution, allowing the capital to grow over time.

Mixed Trusts

Mixed trusts are a combination of more than one type of trust. The different parts of the trust are treated according to the tax rules that apply to each part​³​

Tax Implications: As these trusts are a mix of different types, the tax implications will depend on the rules that apply to each part of the trust.

Wealth Transfer: Mixed trusts can provide flexibility in wealth transfer planning as they can be tailored to meet various needs by combining features of different types of trusts.

Settlor-Interested Trusts

Settlor-interested trusts are where the settlor or their spouse or civil partner benefits from the trust. The trust could be an interest in possession trust, an accumulation trust, or a discretionary trust​⁴​.

Tax Implications: The settlor is responsible for Income Tax on these trusts, even if some of the income is not paid out to them. However, the Income Tax is paid by the trustees as they receive the income. The rate of Income Tax depends on what type of trust the settlor-interested trust is​⁵​.

Wealth Transfer: Settlor-interested trusts can be useful when the settlor wants to retain access to the trust income or capital, while also providing for other beneficiaries.

Non-Resident Trusts

Non-resident trusts are trusts where the trustees are not resident in the UK for tax purposes. The tax rules for non-resident trusts are very complicated​⁶​.

Tax Implications: The tax implications for non-resident trusts can be complex and depend on various factors. It’s recommended to get professional advice when dealing with these types of trusts.

Wealth Transfer: Non-resident trusts can be used by individuals who are not UK residents to manage their assets. They can also be used by UK residents for tax planning purposes, for instance, when the settlor becomes non-UK resident for a period of time. If you’re UK-domiciled and you transfer assets to a non-resident trust, you might be liable to UK tax​⁷​.

Please note, while trusts can provide various benefits in terms of controlling and protecting assets, and potentially mitigating tax liabilities, it’s important to get professional advice when setting up and managing trusts, due to their complexity and the tax rules involved. The information provided here is a general guide and may not be suitable for everyone. It’s also essential to note that tax rules can change and the value of any benefits depends on individual circumstances.

Let’s take a closer look at different types of trusts and their uses in wealth transfer planning in the UK.

Using Bare Trusts in Wealth Transfer

Since the beneficiary of a bare trust has the right to all of the capital and income of the trust at a certain age, it is often used as a tool for wealth transfer to young individuals. For instance, if you wish to pass on assets to your children or grandchildren, you can use a bare trust to ensure that they receive these assets directly when they reach the age of 18 (or 16 in Scotland). Since the beneficiary is responsible for the tax, it might also be advantageous in cases where the beneficiary has a lower tax rate than the settlor.

Using Interest in Possession Trusts in Wealth Transfer

An interest in possession trust can be an effective tool for providing income to a beneficiary during their lifetime while still controlling the ultimate distribution of the trust assets. For example, you might set up an interest in possession trust to provide income to your spouse after your death, with the trust assets then passing to your children when your spouse dies. This can ensure that your spouse is financially secure during their lifetime while still ensuring that the assets eventually pass to your children.

Using Discretionary Trusts in Wealth Transfer

Discretionary trusts offer a lot of flexibility and can be particularly useful when your beneficiaries’ future needs are uncertain. For example, you might set up a discretionary trust to provide for a grandchild’s future educational expenses, with the trustees having the discretion to decide how much to distribute depending on the grandchild’s needs and circumstances at the time.

Using Accumulation Trusts in Wealth Transfer

Accumulation trusts can be a good choice if you want to add to the trust’s capital over time. For example, if you’re accumulating wealth for future generations, you might set up an accumulation trust that allows the trustees to accumulate income within the trust, thus increasing the amount that will eventually be available to the beneficiaries.

Using Mixed Trusts in Wealth Transfer

Mixed trusts can be useful when you have multiple goals that might be best served by different types of trusts. For example, you might have an interest in possession trust for your spouse combined with a discretionary trust for your grandchildren.

Using Settlor-Interested Trusts in Wealth Transfer

If you’re considering wealth transfer but also want to retain some access to the trust assets, a settlor-interested trust could be an option. For instance, you might set up a discretionary trust that allows the trustees to make payments to you if necessary, while still providing for other beneficiaries.

Using Non-Resident Trusts in Wealth Transfer

Non-resident trusts can be useful in certain circumstances, particularly if you or your beneficiaries are not UK residents. However, the tax rules for non-resident trusts are complicated, so professional advice is essential.

Trusts can be a powerful tool in wealth transfer planning. They provide flexibility, control over assets, potential tax benefits, and can be tailored to fit your specific circumstances and goals. Each type of trust has its advantages and disadvantages, and the right choice will depend on your individual circumstances and objectives. Therefore, it is advisable to seek professional advice before setting up a trust for wealth transfer planning.