Trusts are legal entities that allow someone to benefit from an asset without being the legal owner.
Trusts are set up for a number of reasons, such as to control and protect family assets, for the benefit of someone who is too young or incapacitated to handle their affairs, or simply to pass on assets both in lifetime and in death.
Different kinds of assets can be put in a trust, including:
- Cash
- Property
- Shares
- Land
There are different types of trusts available and they are taxed differently. The trust you may wish to choose at some point largely depends on your objectives and how you want your assets to be controlled. It can be set up during your lifetime (by using a trust deed) or upon death (by inclusion in your Will).
Each can involve important roles**, such as a ‘settlor’, ‘trustee’ and ‘beneficiary’. In this guide, we’ll explore the different types of trusts and tax responsibilities you may need to be aware of.
Understanding the different types of trusts:
Will Trusts.
A Will Trust or ‘Testamentary Trust’ is only created upon death, however, you can set up the trust as part of your Will. This places assets in the control of named persons (called trustees) on behalf of designated beneficiaries.
Will Trusts can help with effective Inheritance Tax planning, however, there are many different options so it’s important that you select the one with your individual situation in mind.
Lifetime Trusts.
Lifetime Trusts are different from Will Trusts because they are established straightaway and not upon death. With a Lifetime Trust, you can protect your most valuable assets, such as your property, whilst you are alive. Those assets become the property of a Lifetime Trust which must be managed and looked after.
Discretionary Trust.
A Discretionary Trust is when money or other assets from your estate are left in a trust.
This trust gives the trustees the discretion to decide which of the Will’s beneficiaries to pass trust assets on to, how much they will receive, and when they will receive it.
Discretionary Trusts are sometimes set up to put assets aside for a future need, like grandchildren, or beneficiaries who are not capable or responsible enough to deal with money themselves. These can be established in the lifetime as well as by Will.
Fixed-Interest Trust.
Any beneficiaries who are children will inherit when they turn 18, however you can increase this age to 21, 25 or higher if you wish. This can be an option if you’re satisfied the beneficiary will be capable of managing the inheritance on their own.
Property Protection.
A Protected Property Trust is a form of last Will and testament used by property co-owners.
It can help to protect property from being used to pay for long-term care fees as you can effectively ring-fence your share of the property by placing it in a trust on your passing. This gives your spouse or partner the right to continue to occupy the property as if they still owned the whole property, or vice versa.
If the surviving spouse or partner then required long term care in the future, only their own 50% share of the property could be used to fund their care.
Flexible Life Interest.
A Flexible Life Interest Trust (FLIT) is a mixture between a Life Interest Trust and a Discretionary Trust. The trust will name a life tenant and other discretionary beneficiaries.
This type of trust usually arises when a beneficiary is left a lifetime interest in property (and often assets). It can be used to ensure that a portion of the estate is protected against a future marriage or relationship or any other difficulties that the surviving spouse or partner could encounter after your passing.
Bare Trust (or Simple Trust).
A Bare Trust is an arrangement whereby the Settlor allows assets to be held by a trustee on behalf of a specified beneficiary or beneficiaries.
Assets are held by a trustee until the beneficiary is 18 years old, at which point they have the right to all the income and capital of the trust immediately. Beneficiaries are liable for Income Tax – however, they may be exempt from Inheritance Tax as a Bare Trust is treated as a ‘potentially exempt transfer’. In this case, Inheritance Tax will only be payable if the settlor dies within seven years of setting up the trust.
Interest in Possession Trust.
Interest in Possession (IIP) Trusts give a named beneficiary (or beneficiaries) the right to any trust income. The trustee must pass on all trust income to the beneficiary as it arises and so the beneficiary can receive income from the trust as soon as the trust is set up. This type of trust can be set up by an individual as settlor in their lifetime or can be set up on death through intestacy or Will.
Acting as a trustee.
A trustee is responsible for managing the assets in a trust and fulfilling the purpose of the trust.
Managing a trust can be complicated and the role carries a lot of responsibility. It’s recommended you seek legal advice before agreeing to be a trustee.
Trusts and taxes:
Trusts and Income Tax.
Most trusts do not pay Income Tax on income up to a tax-free amount (normally £500); however, tax is due on the full amount if the income is more than the tax-free amount.
Although trustees do not qualify for the dividend allowance*, different types of trust income have different rates of Income Tax. For example, trustees are responsible for paying tax on income received by accumulation or discretionary trusts.
The Government website* explains more about trusts and income tax (site originally accessed and up-to-date as of 13/05/24).
Tax is subject to an individual’s personal circumstances, and tax rules can change at any time.
Trusts and Capital Gains Tax.
In the case of trusts, Capital Gains Tax is a tax on the gain when an asset that’s increased in value is taken out of or put into a trust.
If assets are put into a trust, tax is paid by either the person selling the asset to the trust or the settlor who is transferring the asset.
Trustees need to work out the total taxable gain* to know if they have to pay Capital Gains Tax, however, they are allowable costs which can be used to reduce gains. Trustees may also be able to reduce or delay the amount of tax the trust pays if gains are eligible for tax relief.
The Government website* explains more about trusts and Capital Gains Tax (site originally accessed and up-to-date as of 13/05/24).
Tax is subject to an individual’s personal circumstances, and tax rules can change at any time.
Trusts and Inheritance Tax:
If you put assets into a trust, Inheritance Tax may need to be paid at various points in the lifecycle of the trust.
When Inheritance Tax is due.
The main situations when Inheritance Tax is due are:
- When assets are transferred into a trust
- When a trust reaches a 10-year anniversary of when it was set up (there are 10-yearly Inheritance Tax charges)
- When assets are transferred out of a trust* (known as ‘exit charges’) or the trust ends
- When someone dies* and a trust is involved when sorting out their estate*
The Government website* explains more about trusts and Inheritance Tax (site originally accessed and up-to-date as of 13/05/24).
Tax is subject to an individual’s personal circumstances, and tax rules can change at any time.
Making the most of trusts.
To make sure you get things right, it’s important to get professional advice before setting up a trust.
If you’re a True Potential Wealth Management client and have any queries about the tax implications associated with trusts, you can speak to one of our financial advisors or call our Relationship Management Team on 0191 500 9164. They’re available 7am-8pm on weekdays and 8am-12pm on Saturdays.
If you’re not an existing client, call one of our experts on 0191 625 0350 to learn more.
The Financial Conduct Authority do not regulate, Will Writing, Tax Advice and Estate Planning. The guidance and/or advice contained within this blog are subject to the UK regulatory regime and is therefore primarily targeted at customers in the UK.
Tax is subject to an individual’s personal circumstances, and tax rules can change at any time. Please note, this blog is not a recommendation or personal financial advice.
Sources:
*Data sourced from gov.uk and accessed on 13/05/24
** Data sourced from True Potential and accessed on 13/05/24
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