Although the focus is often on the potential tax-saving aspects of trusts, an equally important element of transferring assets to a trust is that of asset and beneficiary protection.
The concept of a trust is rooted in English law, dating back to the Crusades. Fearful of grasping neighbours, departing knights transferred land to a trusted friend, because women and children were, of course, deemed incapable of holding it themselves. Then when a trustee failed to hand back the land or otherwise abused his position, rights of redress then arose. And so a rich tradition of trust law has evolved.
As in the 11th century, trusts today can be a useful tool for ensuring that assets are preserved and that they are looked after on behalf of family members who may not be able to do so themselves for various reasons. Where assets are held in trust, the trustees have control over them, and can therefore make certain that the assets (e.g. cash, investments or property) are sensibly managed or invested. For the types of trust discussed here, trustees will have the power to release the income or capital when necessary.
Disabled person’s trust
This is a specific type of trust which can be used to protect a vulnerable person who qualifies as a 'disabled person'. A disabled person is defined in the legislation as someone who cannot manage their own affairs because of a mental disorder, or who is in receipt of certain benefits (attendance allowance, certain disability living allowance payments, personal independence payments, amongst others). They might be vulnerable to financial abuse or exploitation from others, or be unable to manage their own finances.
This type of trust can be created so that the disabled person is entitled to income as of right but not capital (known as a life interest), or as a fully discretionary trust allowing the trustees to make decisions about when and how to distribute income and capital, if at all.
Trusts can be a useful tool for ensuring that assets are preserved on behalf of family members who may not be able to do so themselves.
A disabled person's trust is a special type of trust for tax purposes. Although the assets are controlled by the trustees for the beneficiary’s benefit, for inheritance tax (IHT), capital gains tax and income tax purposes, the trust assets are treated as belonging to the beneficiary. This usually means a lower tax burden, but in order to achieve this, the trust has to be carefully set up, and specific elections must be made on behalf of the disabled person. There is scope to distribute small amounts from the trust to other beneficiaries, but this is limited, so the trust should principally be created just to benefit the disabled person.
Protective trust
Trusts might be appropriate where the intended beneficiary (or their spouse or civil partner) is, or could be, financially irresponsible, perhaps due to addiction or poor financial management skills.
In such a case, there may be good reason to create a protective trust. The beneficiary will be entitled to the income (but not the capital) of the trust as of right, unless certain events set out in the trust take place, e.g., bankruptcy or divorce of the beneficiary, known as forfeiture events. Once such an event takes place, the beneficiary ceases to be entitled to the income, and the trust becomes fully discretionary – i.e., the trustees regain control of the distribution of the trust’s assets.
A discretionary trust provides a great deal of flexibility, allowing the trustees to pay out income or capital at their discretion.
A protective trust initially has similar benefits to a disabled person’s trust, but once a forfeiture event occurs, income is subject to tax at the higher rates applicable to trusts (though credit for tax paid by the trustees can be claimed by beneficiaries receiving income distributions). IHT charges may arise whenever capital assets are distributed, and on every 10th anniversary of the creation of the trust. If the trust is created by a settlor during their lifetime, there may also be IHT charges on creation, depending on the value of the assets being transferred and the IHT position of the settlor.
Discretionary trust
An option is to create a discretionary trust from the very beginning – this carries the same tax burdens as a protective trust after forfeiture, as set out above.
A discretionary trust is often appropriate in situations where the settlor is just not sure whether the intended beneficiaries are sufficiently able or trustworthy enough to receive income as of right, or wants the trustees to consider specific beneficiaries' circumstances and needs before making any payments.
A discretionary trust provides a great deal of flexibility, allowing the trustees to pay out income or capital at their discretion, usually on the basis of wishes expressed by the settlor as to how they would like the trust fund to be dealt with.
Any of the trusts above can be created during the settlor's lifetime, or on death by the settlor's Will. Discretionary trusts are often included in clients' Wills to allow for maximum flexibility. Such a trust can include just some of the settlor's assets, or their whole estate after payment of IHT and administration expenses.
Including a discretionary trust in a Will is particularly helpful because it provides the trustees with a variety of options – for example, the trust can be wound up within two years of death and all assets distributed, if that is deemed appropriate; or it can be retained beyond the two years if it is felt that additional protection is required over the assets.
When creating a trust, it is always worth bearing in mind that there will be administrative costs to running most types of trust, covering compliance and tax reporting requirements.
Nonetheless, a trust can be invaluable in giving peace of mind to settlors who want to ensure that beneficiaries
and assets are protected but require sufficient flexibility
to ensure that their family members will have a financial safety net.
About Hunters Law
Hunters Law LLP is a multi-disciplinary, London-based law firm providing advice to private clients, businesses and charities. It is especially known for its private wealth, property and family law practices.
All views expressed are those of the author and are presented for information purposes only. The information provided in this article is of a general nature and is not a substitute for specific advice about your own circumstances. You are recommended to obtain specific advice from a qualified professional before you take any action or refrain from any action.
