Understanding Trusts: What They Are and What They Cost

Trusts are more common than you may think, and they serve an essential role in estate planning, asset protection, and inheritance tax planning. Many people become beneficiaries or trustees of trusts that have been set up and reach out for clarification on trust matters. It is vital to remember that a trust is a legal entity, and as such trustees have legal obligations much like directors and shareholders of a limited company.  

What is a Trust? 

A trust is a legal arrangement where a person (the settlor) transfers assets into a trust, which is then managed by trustees for the benefit of specific individuals (the beneficiaries). The trustees have a legal duty to manage and distribute the assets according to the trust’s terms. 

A key feature of a trust is that it creates a dual ownership structure: the trustees hold legal ownership, while the beneficiaries have beneficial ownership. There are different types of trusts, each serving different purposes: 

Income in Possession Trust: The beneficiary receives income or access to an asset of the trust but does not own the capital asset itself.   This is commonly seen in death estates where property is left in trust for direct descendants of the settlor with a partner being allowed to occupy the property until their death or another contingent event.  

Discretionary Trust: Trustees have discretion over how income and assets are distributed among beneficiaries, often used for inheritance tax planning and asset protection. 

Bare Trust: The assets are held by a nominee for the beneficiary and act on their behalf until the beneficiary becomes an adult (18). The beneficiary has absolute entitlement to both income and capital, commonly used for children’s savings. 

Bereaved Minor’s Trust: Created for minors who inherit assets following a parent's death, granting full ownership at 18. 

Trusts for Vulnerable Beneficiaries: Designed to protect assets for minors or disabled individuals, with specific tax treatments. 

Each type of trust comes with unique tax implications, including inheritance tax (IHT), capital gains tax (CGT), and income tax. Trusts must also be registered with HMRC, even if they are not taxable. Learn more about the types of trusts and their tax implications here.

Will Setting Up a Trust Cost Me Money? 

Setting up and maintaining a trust can be expensive due to legal fees, taxes, and administrative costs. A trust deed must be created by a qualified legal professional. Once assets are transferred into the trust, reversing the process can be difficult. 

Trust tax rates for discretionary trusts are at the highest rates of tax and there are reduced allowances for CGT.   Discretionary trusts require a 10-year IHT charge to be calculated and there is IHT to consider on assets being distributed.  

While trusts can be beneficial for estate planning and protecting assets, the costs and tax implications can be substantial. Before setting up a trust or if you have just become a beneficiary or trustee of a trust, it’s crucial to explore all options and seek professional advice. Read more about the financial aspects of trusts here.

If you’re considering setting up a trust or have questions about how one might impact your financial plans, get in touch for a review to explore the best solutions for your needs.