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An introduction to trusts

What are trusts, and how can they help me with inheritance tax (IHT) and ensuring my loved ones are looked after? In this guide, our team at Vesta Wealth explains the main types of trust, how they work and whether they can fit into your financial plan, to mitigate needless tax and distribute your assets. 

We hope you find this article helpful. Please contact us if you would like to discuss your situation with your Financial Planner.

What is a trust?

A trust is a legal structure that lets you manage your assets, such as investments, property and cash savings. It can even contain assets like valuable artwork, and lets you transfer ownership of these assets to the trust. This trust is then managed by other people known as trustees. 

The person making the ownership transfer is usually called the settlor or donor. The person (or people) who will eventually receive the assets, such as children, are called beneficiaries.

Since trusts allow the settlor to transfer ownership of their assets, these are typically no longer regarded as the settlor’s possessions. As such, they may no longer form part of his/her estate after their death, which can affect the settlor’s future IHT bill, possibly reducing it.

Reasons to create a trust

Putting some of your assets into a trust can be a good way to control and protect family wealth. For example, if the beneficiaries of your estate are currently too young to receive a large sum of money, then putting assets in a trust can enable you to specify the conditions that they can receive the wealth, such as for a first house purchase. This can help to protect spendthrifts from whittling away your hard-earned money.

Assets within certain trusts are treated differently for IHT purposes. This means that trusts can be a powerful tool for estate planning. Below, we expand on this in more detail.

Different trust types

Trusts come in various forms in the UK, and contrary to what many people think they are not all treated the same for IHT purposes. Here is an overview of the primary types:

  • Bare trusts. Sometimes called a ‘simple trust’, this type of trust requires little/no active duties on the part of trustees (e.g. discretion about what to do with income from assets). After the beneficiary turns 18, they have the right to access to the assets and income at any time. Bare trusts may be IHT-exempt if the settlor survives the transfer by 7 years.   
  • Interest in possession trusts. This trust type passes any income from the trust assets straight to the beneficiaries (after expenses and taxes). For those who put assets into this type of trust before 22nd March 2006, no IHT is likely due upon the settlor’s death. If a transfer occurred after this date, the 10-yearly Inheritance Tax charge may be due.
  • Discretionary Trusts. Here, trustees have a much more active role. The settlor gives them the power to decide upon the timing, size and nature of any wealth and income distributions to beneficiaries – within the remit of the trust deed. An initial IHT charge of 20% may be due on assets when transferred into a discretionary trust.
  • Mixed Trusts. As the label implies, this approach includes different trust types within a single structure. Remember, when putting assets into a trust, each one has its own identity. Some may be designated for trustees to manage at their discretion and, so, will likely be subject to rules governing discretionary trusts. Other assets may be set aside for a beneficiary with a disability – which involve different rules.

Risks and downsides to consider

Perhaps the biggest danger is that people rush into setting up a trust, thinking they can avoid IHT by doing so, without thinking carefully about the best type to use, and how trusts should fit into their wider financial plan. Remember, once your assets are placed into a trust structure, they no longer belong to you. As such, it is usually very difficult if not impossible to reverse the transfer.

Trusts are complex legal structures involving many rules which may be subject to change. Be careful, therefore, about storming ahead with a DIY approach. It is also important to consider the potential risks of specific trust types. 

For instance, with discretionary trusts, you need to be confident that any trustee(s) you appoint will have you and your beneficiaries’ best interests at heart when making decisions about the timing, size and nature of distributions. If there is a high risk that poor choices might be made after your death which adversely affect your loved ones, then perhaps you need to consider different trust types, or different trustees.

Invitation

Remember the basic rule when thinking about trusts and IHT: for most trust types, IHT is due when the value of the transfer(s) exceeds your IHT-free threshold of £325,000. This may sound simple, but working it out is complex, often requiring help from a Financial Planner.

If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.

Reach us via:

t: 01228 210 137

e: [email protected] 

This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.

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December 13th, 2021