What is a trust? The pros and cons of setting up a trust

12 November 2023

Estate Planning / IHT, Property Investors & Developers, Property Owners, Reducing Tax

When good professional advice is taken on both the tax and legal aspects of forming a trust, they really can be a very efficient way to reduce tax in a number of scenarios.

Trusts can also provide some very important practical benefits in financial management and asset protection and can ultimately help you retain family wealth.

What is a trust?

There are a number of different types of trust, each with their own rules and benefits, but let’s start with the basics.

Essentially a trust is a legal arrangement which deals with how a number of different assets, such as cash or property, is owned and managed.

A trust deed would be written up by a solicitor and then the tax obligations looked after by either yourself or an accountant.

There are three parties involved:

The settlor

This is the person who is putting something into the trust, like a property they hold.

The beneficiary

This is the person, or people, who receive the benefit of the asset that the settlor is putting into the trust

The trustees

These are the people who the settlor appoints the responsibility of managing the assets on behalf of the beneficiary.

What are the pros of setting up a trust?

Trusts are bespoke and can be set up in varied ways to suit the needs of the settlor, some of the ways they can be used are as follows:

Staying in control

You may want to gift an asset to a child say, but realise they aren’t ready for the responsibility.

A bare trust could be used so that you can make your gift, but still maintain control of it until the child is old enough to take legal ownership.

Protect vulnerable loved ones

Perhaps a relative is unable to manage their finances due to illness or disability, a trust allows you to manage their assets on their behalf.

This can also be a useful arrangement where an individual is in receipt of means tested benefits; for example an injury may have been sustained leaving a relative unable to work.

A compensation pay out could be held in trust, meaning any means tested benefits received aren’t affected.

Wealth protection

Placing valuable assets into trust takes them out of that person’s estate.

This means that they usually can’t be considered in divorce proceedings and are unavailable to be seized upon bankruptcy.

Life interest trusts can also be used to allow a certain person the use of an asset for their lifetime, but a different person is entitled to own the asset upon their death – this could be effective where you’re concerned with re-marriages within the family for example.

Protection from care home fees

Having assets in trust may allow them to be protected from care home fees, however you must be careful as local authorities are able to ignore the trust if they believe this was the primary motive for setting up the trust in the first place.

Minimising inheritance tax

Most trusts have their own nil rate band for inheritance tax (currently £325,000) meaning that broadly a person can make a gift of up to £325,000 into a trust once every 7 years completely tax free.

This can be a very effective tool to reduce the value of your estate for inheritance tax purposes and is further explored in our blog Using Trusts to save Inheritance Tax.

Income tax savings

A very simple type of trust arrangement may be to gift half of the beneficial interest of your rental property to your spouse to make use of any unutilised tax allowances and reduce the overall tax on the rental income.

Discretionary trust arrangements can also be used to distribute income to other family members who perhaps have low or no income, again to utilise their tax allowances.

What are the downsides to setting up a trust?

Costs

As with everything in life, there comes a cost.

There will be solicitor fees to draw up the trust agreement and then perhaps accountancy fees for the registration and annual tax return.

We typically charge around £250 plus VAT for a trust registration and around £1,000 plus VAT for a trust tax return.

Not all trusts require annual tax returns however.

Gifts with reservation of benefit

Many trusts are set up for the purpose of reducing inheritance tax.

However you must bear in mind that if you gift something away into a trust but still enjoy the benefit of it (perhaps you put a property into trust and still live there or have set up a trust for your minor children), then this will still be included in your estate for IHT purposes, and the tax planning here would have failed.

10-year anniversary charges

Certain types of trusts, e.g discretionary trusts, are liable to an IHT charge at every 10 year anniversary of their creation.

At this time, the value of the trust assets is compared with the IHT nil rate band of £325,000 and any excess is charged to IHT at around 6%.

This is not applicable to all trusts and can be managed with effective tax planning.

In conclusion

Trusts are a relatively underused and highly effective tax planning option in a number of scenarios.

The benefits are so wide that there’s simply not enough space to discuss them all in this blog!

Interested in how a trust could benefit you?

Trusts are tailored arrangements, so if you’re interested in how a trust could benefit you then please contact either Jan Friend or Christie Inns and they will be happy to assist you.

We can help with all areas, from assisting with arranging the trust formation, registration with HMRC and completion of the tax affairs.