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What are the Different Types of Trusts?

08 Sep 21

For many of us, having peace of mind that our loved ones’ futures are financially secure when they grow up or when we pass away is a top priority. A great way to ensure this is by setting up a trust. Learn more about what trusts are, why they’re useful for storing assets, the different types of trusts and how to set one up.

What is a trust?

A trust is a legal arrangement that allows assets such as money, investments, property and land to be transferred from one individual (the ‘settlor’) to another (the ‘beneficiary’). It’s usually set up by creating a ‘trust-deed’ – a written document that outlines how the settlor wishes for the assets to be used. Multiple people may be named as beneficiaries and benefits include the income of a trust only, the capital only or a combination of the two. A trust must be managed by one or more ‘trustee’. This is the legal owner of the assets in a trust, whose responsibility it is to manage the trust, pay any tax, and ensure its assets are handled in the way the settlor intended.

Reasons for setting up a trust

There are a variety of reasons for setting up a trust. For example, it helps to control family assets and pass them on while you’re still alive or transfer them to others when you pass away (also known as a ‘will trust’). If someone is unable to handle their affairs, either because they’re too young or incapacitated, having a trust in place ensures their finances are protected and used appropriately.

Another key reason many people decide to open a trust is to reduce inheritance tax. In most cases, when the combined value of an estate exceeds £325,000, beneficiaries are required to pay 40% inheritance tax. However, no inheritance tax is due on any wealth that’s stored in a trust. Whilst this enables beneficiaries to receive the full value of whatever is left to them, this transfer must have occurred at least seven years before the death of the settlor. For more information on this, read our blog on Inheritance Tax Advice and FAQs.

Main types of trusts

When it comes to trusts, there’s no one size fits all solution - after all, everyone’s financial situation and view on how their assets should be managed is different. This is reflected in the variety of different types of trusts available. Here we breakdown the four most used trust structures and how they’re taxed differently.

Life interest trusts

Couples that are married, in a civil partnership or cohabiting often make wills which entitle one another to all their estate once they die. A life interest trust allows the surviving partner to benefit from these assets whilst they’re still alive or until they remarry. However, the surviving partner doesn’t legally own the estate, so is unable to transfer it or use its value to cover care expenses.

The life interest trust ends following the death of the second partner, at which point the estate passes on to its beneficiaries (usually the couple’s children if they have any). This ensures beneficiaries don’t miss out on receiving the settlor’s assets, which can sometimes happen if the deceased’s partner goes on to have children with someone else or requires expensive care arrangements.

If income is paid to a life interest trust the trustees must pay tax at 7.5% on dividend income and 20% on all other incomes. The beneficiary of the trust is entitled to all income and so should declare the income and tax suffered on their personal tax returns. Depending on their personal circumstances, they may be due a refund of tax or if they’re a higher rate tax payer have an additional tax liability on the income. If the income goes directly to the beneficiary no tax is paid by the trustees, instead, the beneficiary is responsible for declaring and paying the appropriate tax.

Discretionary trusts

Discretionary trusts enable the trustee to decide how the trust income (and sometimes capital) should be used. This may include choosing which beneficiary to allocate assets to, deciding how often they receive the benefits, or whether they want to impose certain conditions on them. Discretionary trusts are commonly used to store assets for grandchildren or those with difficulties that prevent them from handling money responsibly. With discretionary trusts, income distributions are paid net of 45% tax, and beneficiaries whose income is taxed at basic or higher rates can claim a refund of tax from HMRC.

Accumulation trusts

If a settlor wants the trustee to accumulate income in the trust over time, they should opt for an accumulation trust. Income is typically accumulated and added to the trust’s capital until the beneficiary becomes legally entitled to the trust assets. Income distributions are treated the same as for discretionary trusts.

Bare trusts

A bare trust is a popular choice amongst those looking to pass their assets on to a young person. In England and Wales, once the beneficiary turns 18 (or 16 in Scotland), they’re entitled to the value of everything that’s left to them in the trust. However, until they reach this age, the assets are looked after by the trustee. As all income generated goes to the beneficiaries, they or their guardians are responsible for paying any tax due on income that arises.

How to set up a trust

To ensure your trust is set up and managed correctly, consider enlisting the help of a trust accountant. At Hysons, we have a long history of assisting in this process and provide expert advice on the following:

  • Deciding what assets should be stored in the trust
  • Identifying who you want to nominate as beneficiaries
  • Choosing which type of trust is most suited to your needs

We can set up the trust on your behalf and act as the trustee, dealing with administration such as tracking deposits and paying tax on time. Our team of trust accountants are also on hand to monitor the effectiveness of your trust and keep you abreast of any changes and deadlines. If you’d like to learn more about opening a trust and the role Hysons can play in managing it successfully, don’t hesitate to get in touch with us today!

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