A Trust is an arrangement whereby assets (the Trust Fund) are managed by Trustees on behalf of a third party or parties (beneficiaries).  The person transferring the assets into the Trust is known as the Settlor or Transferor. 

A Trust ensures the people you choose are the only ones who can benefit from the Trust Fund and it essentially ring-fences assets which are often diluted because of possible future marriages; divorce; spendthrift dependents; beneficiaries with alcohol or substance abuse problems; and can be used to mitigate inheritance tax and reduce probate costs and times.  Trusts can also protect assets from being used to fund long term care fees, provided they have not been set up for that reason. 

Various assets can be transferred into a Trust which can include property and land, cash, shares, bonds, valuable items (family heirlooms), business shares, etc. There are some assets which cannot be placed into a Trust, for example ISA investments. 

Trusts can be created on your death by your Will, by the laws of intestacy (dying without a Will), by Deed of Variation (changing a Will after someone dies) or you can transfer assets into Trust while you are living (see our Lifetime Trusts page). 

Generally Trusts will either give someone an absolute right to income and capital of the assets within the Trust; give an individual an interest immediately on death (interest in possession) known as a life interest; or will be discretionary (distributed at the Trustees discretion) and some Trusts incorporate both latter elements. 

Setting up the Trust

The Grant of Probate is first obtained (see our Probate page).  Then the Executors arrange for a legal Deed to be drawn up together with certain forms which must be completed and submitted to the Land Registry.  We can arrange this when the time comes. 

Life Interest Trusts

A Life Interest Trust is a most flexible and useful device as well as creating security and control over assets from the grave. 

A life interest Trust allows Trustees to hold assets for an individual (the life tenant) who is given a right to any income produced by those assets and allows the life tenant to occupy Trust property rent free. 

You can choose the duration of the interest (for instance, for their lifetime or until they reach a certain age) and you are free to impose conditions (for example you can say the interest will end if the life tenant remarries).

The person entitled to it (the life tenant) must have become entitled to it on the death of the person granting the Life Interest. 

The typical scenario for most couples is that they wish to leave everything to each other on first death and then to children or other beneficiaries on second death. 

Unfortunately however, after the death of the first, if the survivor of a couple decided to change their Will or got married, the intended beneficiaries could end up receiving nothing. 

A Life Interest Trust can be used to ensure only the people you choose can benefit from your estate but still protects the survivor by enabling them to benefit during the trust period. 

Once the life interest ends (usually when the life tenant dies; remarries; or gives up their right to benefit), the Trust assets are then appointed out to the beneficiaries you have chosen or they can be held in a discretionary Trust. 

TAX: Life Interest Trusts

The Life Interest grants the Occupant an ‘interest in possession’ and is taxed as such. 

The life tenant is entitled to all income (after expenses) as it arises.  The Trustees must pay tax on the income before it is passed to the life tenant. 

Annual tax returns have to be filed by the Trustees and the Trust income is charged at 20% or 7.5% on dividend-type income. 

If the life tenant is a basic rate taxpayer they will not owe any extra tax on the income.  They will need to file a tax return if the income they receive from the Trust takes their total annual income into a higher rate income tax band.  If they are not a tax payer they can reclaim the tax paid.  Higher rate tax payers will have to pay the difference between the tax the Trustees have paid and what they are liable for through their self-assessment. 

If income is mandated directly to the life tenant they would file it on their own tax return and would be taxed at their normal rate instead of going through the Trustees. 

If the life tenant asks the Trustees for a statement they must tell them the different sources of income; how much income has been given to the life tenant; and how much tax has been paid. 

If the life tenant is not a spouse or civil partner then there needs to be consideration of inheritance tax. 

Capital Gains Tax may be due if Trust assets are sold, given away, exchanged or transferred in another way and they’ve gone up in value since being put into the Trust. 

28% Capital Gains Tax is only paid by Trustees if the assets have increased in value above the Trustees’ available annual exemption.  The Trustees’ annual exemption is a maximum of one half of the individual’s annual exemption. 

Capital Gains Tax is not payable if the Trust property is transferred to someone else when the life tenant dies. 

If the life tenant gives up their interest it will be held as part of their Estate for seven years after which it will be outside of their Estate for inheritance tax purposes. 

If a life tenant dies living in a property via a Life Interest Trust, it will be seen as part of their Estate for inheritance tax purposes, despite already being held as part of your Estate on your death. 

If the occupant has been granted the right to reside for a number of years, at the end of the Trust period HMRC will hold it as part of their Estate for seven years after which it will be outside of their Estate for inheritance tax purposes. 

Right to Occupy Trusts and Protective Property Trusts

These Trusts are specifically for property and land.  A Right to Occupy Trust grants a person or persons the right to occupy trust property free of rent.  A Protective Property Trust does the same but also gives them the right to receive any income produced by the property held in the trust. 

These trusts can include powers to sell the property at the request of the Occupant(s) and hold the substituted property on the same terms.  This can be particularly useful for those who may need to downsize in the future. 

The Occupant(s) is not entitled to the capital.  They are simply given the right to benefit from the trust property until the Trust ends or they relinquish their entitlement. 

You can choose the duration of the interest (for instance, for their lifetime or until they reach a certain age) and you are free to impose conditions (for example you can say the interest will end if an occupant enters into a marriage or civil partnership).

TAX: Right to Occupy Trusts and Protective Property Trusts

The right to occupy is created by the Will and takes effect immediately upon death.  It grants the Occupant an ‘interest in possession’. 

If the Occupant is not a spouse or civil partner then there needs to be consideration of Inheritance Tax. 

Capital Gains Tax may be due if Trust assets are sold, given away, exchanged or transferred in another way and they’ve gone up in value since being put into the Trust. 

28% Capital Gains Tax is only paid by Trustees if the assets have increased in value above the Trustees’ available annual exemption.  The Trustees’ annual exemption is a maximum of one half of the individual’s annual exemption. 

If the Occupant dies during the Trust, it will be held as part of their estate for Inheritance Tax purposes, despite already being held as part of your Estate on your death. 

If the Occupant has been granted the right to reside for a number of years, at the end of the Trust period HMRC will hold it as part of their Estate for seven years after which it will be outside of their Estate for Inheritance Tax purposes. 

Discretionary Trusts

A discretionary Trust can run for up to 125 years and allows you to choose multiple beneficiaries or classes of individuals (children; grandchildren; etc.).  It allows the Trustees to use the Trust in a discretionary format and the income and capital can be appointed out as they see fit and taking into consideration any letter of wishes you leave detailing your intentions. 

Assets held in Discretionary Trusts are held entirely by the Trustees who control which of the beneficiaries benefit, in what quantities and when. 

Discretionary Trusts are particularly good for people looking to generation skip (useful for mitigating inheritance tax); to control who receives money at the discretion of the Trustees; to look after minors; to manage money and assets for individuals who are unable to look after it themselves; to protect against those with alcohol or drug addition problems; as a way of protecting a legacy; and excluding people you do not want to benefit. 

TAX: Discretionary Trusts

The Trust has an allowance of £325,000.  The value of the assets held in the Trust then need to be looked at every 10 years.  If, at that time, the Trust Fund exceeds the £325,000 threshold, there will be (up to and often lower than) 6% charges to pay on the amount above the allowance.  There are also exit charges when distributions of capital are made if the Trust exceeds the allowance. 

These Trusts also have their own tax rules on any income produced by the Trust Fund.  The first £1,000 will be taxed as 7.5% on dividends and any other income will be taxed at 20%.  Anything after will be taxed at a rate of 45%, 37.5% for dividends. 

Beneficiaries who receive income will be taxed at their standard rate of tax.   The recipient of any Trust Funds which have been taxed at a higher Trust tax rate can claim relief on the money which the Trust pays by offsetting it against their personal tax. 

Capital Gains Tax may be due if Trust assets are sold, given away, exchanged or transferred in another way and they’ve gone up in value since being put into the Trust. 

28% Capital Gains Tax is only paid by Trustees if the assets have increased in value above the Trustees’ available annual exemption.  The Trustees’ annual exemption is a maximum of one half of the individual’s annual exemption. 

Please note: if you put your main residence into a Discretionary Trust then your executors will not be able to claim the Residence Nil Rate Band (RNRB) on your Estate after your death which aims to enable you to leave your property to your descendants free of Inheritance Tax. 

Children’s Trusts (18-25 Trusts) and Bereaved Minors Trusts

These trusts can arise by the Will or Deed of Variation or by an appointment out of a Trust created by the Will, of a parent or step-parent.  Or by the Criminal Injuries Compensation Scheme or the Victims of Overseas Terrorism Compensation Scheme. 

Bereaved Minors Trusts

These arise where there is a minor child who has not attained 18 years of age and at least one of their parents or step-parents has died. 

Bereaved Minors Trusts will arise and be taxed favourably provided these conditions are met:

  • The child must, on or before attaining the age of 18, become absolutely entitled to all of the Trust assets and all of the income including any income that has been accumulated;
  • During the Trust period, any of the Trust capital and income (beyond the annual limit) must be applied for the benefit of the child; and
  • The child must either be entitled to all the income arising from the Trust assets or no such income must be applied for anyone else (beyond the annual limit).

The annual limit is the lesser of £3,000 or 3% of the value of the Trust assets during the Trust period. 

Children’s Trusts (18-25 Trusts)

Many people have concerns about the effects a large inheritance would have if children received this on their 18th Birthday.  These Trusts can be used to ensure children receive money and assets when they are more mature and less likely to squander it. 

These Trusts enable the Trustees to hold the Trust assets for the child until they have attained a certain age (between 18 and 25). This can be particularly important. 

These Trusts will qualify as 18-25 Trust provided three conditions are met:

  • The child must, on or before attaining the age of 25, become absolutely entitled to all of the Trust assets and the income including any income that has been accumulated;
  • During the Trust period, any of the Trust capital and income (beyond the annual limit) must be applied for the benefit of the child; and
  • Either the child must be entitled to all the income arising from the Trust assets or no such income must be applied for anyone else (beyond the annual limit).

The annual limit is the lesser of £3,000 or 3% of the value of the Trust assets during the Trust period. 

Maintenance and Advancement

The Trustees have powers that allow them to pay the income at their discretion, to the beneficiary during their minority. Any income that is not distributed during this time will be accumulated.  Once the beneficiary reaches 18, the Trustees must pay all of the income to them as it arises.

The Trustees also have powers that allow them to advance capital for the benefit of the beneficiary. They can advance assets or cash but if they exercise this power they must ensure the cash is used for the purpose to which it was intended. 

TAX

The Inheritance Tax advantages for these Trusts are automatic, however, the Capital Gains Tax (CGT) and Income Tax advantages will be dependent upon the Trustees having completed a Vulnerable Persons Election (VPE1) and sending this to HMRC. A separate VPE1 must be completed for each beneficiary.  

Until the child reaches 18:

Inheritance Tax

  • Taxed at the usual rate when the parent or step-parent dies
  • No 10-year anniversary charge
  • No exit charges when the assets leave the Trust

Income Tax

Provided a VPE1 has been submitted to HMRC, the Trustees will be entitled to an income tax relief that results in the Trust being taxed as if the income was that of the child.  

Capital Gains Tax (CGT)

If the fund is distributed on or before the child reaches 18, Hold-over relief is available. Hold-over relief allows the CGT to be deferred and paid when the asset is eventually sold.  If the child dies before reaching 18, then no CGT will be payable.   

During the administration of the Trust, CGT will be charged as if it arose on the beneficiary, rather than the Trustees, providing a VPE1 form has been completed and sent to HMRC. If no VPE1 has been submitted to HMRC CGT will be taxed at the Trustee higher.  

After the child reaches 18:

Inheritance Tax

  • No 10-year anniversary charge
  • Exit charges when the assets leave the Trust

Income Tax

Taxed at the Trustee rate (38.1% on dividend type income and 45% on all other income)

Capital Gains Tax (CGT)

Hold-over relief is available when assets distributed to the beneficiary

Trustee higher CGT rate applies otherwise (28% on residential property and 20% on other assets)