About this series of articles
This article is one in a series about how to write a will. The series combines explanations of the law with practical considerations. We hope that it both thorough but also easy to digest.
What is a trust?
We tend to misuse the term trust.
Technically, a trust is a rule (one of many) for how one or more people (known as the trustees) hold money, property, possessions and investments for the benefit of one or more other people (known as the beneficiaries).
More often, we use the word trust fund to refer to the assets held on trust together and we shorten the term further to just trust.
A trust fund is technically called a settlement, but other than lawyers, few people use that term.
Trust powers are what you say your trustees can do or must do. Powers can be as wide ranging or as narrow as you want, but be careful to make sure that what you ask can be done. If it turns out that the trustees cannot do as you ask, then they may have no alternative than to ask a judge, and spend trust money on legal fees.
Why you may need a trust
Trusts are used for many purposes. There are different types of trust funds each with properties or rules that make them useful in certain situations.
If you fail to provide for a trust when the law says you must have one, the Court will set it up for you - possibly entirely against what your wishes might be.
This happens most commonly where a will maker (known as the testator) fails to provide a trust for their children under 18. In this scenario, the Court appoints trustees. The powers they are given are, by default, tightly circumscribed by the Trustee Act 2000. The trustees have no alternative than to hold the property for the child or children until their 18th birthday(s). So if you have any child beneficiaries (or could have), then you should appoint trustees and their powers yourself in your will.
A trust created by your will is called an express trust. An express trust can be either an absolute trust or a discretionary trust. If an absolute trust requires only the happening of a conditional event, it is also called an interest-in-possession trust. There are other types of trusts as well.
In an absolute trust, the identities of the beneficiaries and their entitlements are specified precisely.
In a discretionary trust, the trustees have a discretionary power to distribute the income and capital of the trust fund in proportions they decide.
You may decide to use an absolute trust for many reasons:
To provide for a surviving spouse or partner who is not the parent of your child
This is usually done by setting up a trust where your spouse or partner is a life beneficiary and one of the trustees, and someone else such as your child from your first marriage is an ultimate beneficiary.
If you foresee problems in agreement between the trustees, you might additionally appoint a professional trustee or trusted friend to balance the power.
This structure provides an income for your surviving spouse, maybe access to capital too, if you so choose. However, the bulk of the capital in the trust fund is accumulated for your children.
To create a life interest in a property
If you want someone to live in your house only for their lifetime, you cannot give them the title deeds. Nor do you do want them to be a mere tenant who can be evicted by the real owner.
So you give them a life interest by creating a trust and they become a lifetime beneficiary.
You set out the terms of their occupation, usually just allowing them to occupy the property as their home and as they have always done. The trust deed states what the trustees are to do with the property when the lifetime beneficiary dies.
Usually, the trustees transfer it to children or maybe a charity on your wishes, and the trust automatically comes to an end.
To hold property for children
If parents die, leaving children, it would be sensible to have made a will appointing guardians who would also be trustees.
In this case you would set up one trust to hold assets exclusively for your children. The trustees would probably also be the named guardians of your children. (You would have to ask them first, to be safe).
Then, if you need a trust for any other circumstance, that would be a separate trust, probably with different trustees and different instructions as trust powers.
To hold land or financial assets or a business or the shares in a company for the benefit of a class of people who may be different from the directors or managers
You may have an active involvement in a business such as a family company. Or your property may need to be actively managed.
When you die, you might want your beneficiaries to have the value of your shares, land or financial assets, but you might not think that the beneficiary is qualified to manage them.
A trust holds the value of the assets for the beneficiaries, while giving the trustees (who should be qualified) the responsibility to manage.
An adult (over 18 years) beneficiary of an absolute trust can challenge any delay or condition in court, but in practice that very rarely happens.
You can read more about preserving a family inheritance.
How is a trust created?
When a testator dies their executors go through the process of probate to obtain a grant of probate (legal entitlement to deal with their estate). If they are the trustees, property passes to them immediately, creating a trust (if the will requires one). If the executors are not also the trustees, then in due course, they transfer property to the trustees, thereby creating the trust.
The trustees must then register the trust with HM Revenue & Customs (HMRC) who send a short form for the trustees to complete. The trust is subject to income and capital gains tax in much the same way as an individual, but at different rates.
How is a trust taxed?
Tax rates can change at every Budget. Sometimes, no change is made. But unless you die soon after making your will, it is likely that by the time you die, tax rates will have changed. If you have a will that creates a trust, you should follow changes to the tax rates on HMRC's website.
Usually, distributions of income to beneficiaries, including the surviving spouse or civil partner, will suffer income tax in the hands of the beneficiary but with a credit for the tax paid by the trustees. To the extent that the tax paid by the trustees exceeds the income tax liability arising to the beneficiary on such income, a tax refund will be made to the beneficiary.
Distributions of capital will usually be free of inheritance tax (because it has already been paid when the assets were put into trust) but may be subject to capital gains tax based on the acquisition price of the donor or testator.
Currently, a discretionary trust is subject to inheritance tax every 10 years after the creation of the trust.
There is also a charge when assets cease to be held in a discretionary trust, e.g. if assets pass out of trust to a beneficiary. In this case, the charge to tax is based on:
- the value of the property leaving the trust
- the proportion of the period of 10 years for which the assets have been held on discretionary trust since the last 10 year charge
- the rate of tax at the last 10 yearly charges
The most common reasons for using a discretionary trust are:
To save inheritance tax
In law, a person listed as a discretionary beneficiary cannot, by definition, be the owner of any part of the trust fund because he may never receive any payment. The trustees may exercise their discretion against him.
This simple proposition enables the trustees to arrange the management of the trust fund in ways which minimise their legal obligations to pay tax.
Do not confuse this with a tax scheme. This is very basic law.
Of course, you do have get the words right in drawing the will in the first place. For more information on basic inheritance tax management, read about the nil rate band, discretionary trusts and the 2-year concession.
To allow for future happenings which are quite unforeseeable today
For example, to provide for future grandchildren, some of whom may be unborn when your will is made.
In the hope that bad things will not happen in the future
A discretionary trust enables trustees to avoid distributing trust money to beneficiaries who may not use the money sensibly, or who may have the money taken from them (for example, as the result of a divorce).
Using a discretionary trust
In a discretionary trust, no beneficiary has a right to demand income.
The beneficiaries are named either as a group or by names. Commonly, the list would be children, and remoter relatives. As a generalisation, a discretionary trust works best with a large number of prospective beneficiaries. This is because the eventual payouts are less easily identifiable by HM Revenue and Customs or by a divorce lawyer.
It sounds risky to hand your assets to trustees who may just decide to take an action you would not even have contemplated. To some extent it is.
However, you can reduce the risk by appointing one professional trustee, like a solicitor or accountant, as well as trusted friends or relatives (see our separate article on choosing trustees).
It is also essential to reduce the risk further by preparing a letter of intent that sets out your exact real wishes as to who gets what and when. This letter does not have the force of law, like your trust deed or will, but it is rare that a testators clear wishes are not followed.
Who holds or knows about that letter is your decision, but let us say you would be wise to limit the circulation list.
Because it is so important both to comply with the law and with your wishes, when drawing trustee powers in your will, most lawyers opt out of using any words which they have not seen used for centuries. (We exaggerate, but the language is often impossibly archaic.)
Alternatively, a lawyer might draw trustee powers at very great length so as to impress their client. It is easy to find examples of wills that have multiple pages of unintelligible gobbledygook.
But trust law is complicated. Words and phrases used in the past do have known and accepted meanings. Despite our drive to remove jargon from legal documents, we ourselves have to use more technical-legal words in our wills than in any other document we draw.
We believe that every adult should have a last will and testament. As such, we provide some of our more straightforward wills absolutely free with no catches or conditions.
Visit our library and choose the most suitable last will and testament template. We offer nine in total that together cover thousands of possible variations of wishes. There will be one to suit your situation. If you are in doubt as to which to choose then you can read about which will to choose.