Cheatsheet: A Simple Guide to the Different Types of Trusts in the UK
Many people will come into contact with a trust in one form or another at some point in their lives.
The trust fund landscape in the UK can be difficult to understand. We have put together this simple guide to help you understand the most important aspects. We begin with the basics:
What is a trust?
A trust is a means of managing assets (land or building, investments or money) for people. There are several different types of trust, each of which is taxed differently.
Trusts involve the following:
- A ‘settlor’ – the individual who puts assets into a trust.
- The ‘trustee’ – the individual who manages the trust.
- The ‘beneficiary’ – the individual who benefits from the trust.
Most commonly the three partaking parties are usually different. However, this is not always the case and the settlor or trustee of a trust can also be the beneficiary of the same trust.
Before the creation of a trust, the settlor holds equitable title to the assets proposed for the trust. Upon creation of the trust, the settlor transfers the legal title to the assets to the trustee. The legal title may then stand either in the name of another person on behalf of the trustee or in the trustee’s name. The settlor must appoint a trustee and a beneficiary and set the rules by which the trustee may administer the trust.
The trustee may be a person or an entity (with the latter, typically management fees are charged). You are able to have multiple trustees. The beneficiary may be a person or an entity too (for example, a charity). You are also able to have multiple beneficiaries.
Once the transfer of assets to the fund has taken place, the assets cease to be personal possessions of the settlor. As such, they become immune to any claims from creditors, family disagreements, bankruptcy cases, financial setbacks, and lawsuits.
Benefits of a trust fund
- Setting up a trust fund is a good way to ensure that your assets are distributed to the right people, whether this happens during your life or once you have passed away. You might, for example, set up a trust fund to provide money for education for your grandchildren.
- Trusts can also be set up to protect and control family assets. Trusts can minimise estate and inheritance tax (IHT) liabilities.
- Trusts can be established to protect from excessive, damaging, or unrestricted spending.
- Trusts can also be used for proper management of assets on behalf of a minor (under the age of 18) or an individual who is incapacitated.
- Trusts are also used to act as a contingency fund to protect and take care of the settlor whilst maintaining control of the assets should one become incompetent (due to decline in mental or physical health).
Roles of participating parties
Settlor: the person who decides how the assets which are placed into a trust should be used – this is normally set out in a document called the ‘trust deed’.
In some cases, the settlor may also benefit from the assets placed in a trust – this is called a ‘settlor-interested’ trust and has special tax rules.
Trustees: these are the legal owners of the assets held in a trust. Their role is to:
- Manage to trust on a day-to-day basis and ensure any tax due is paid.
- Handle the assets in the trust according to the settlor’s wishes, as set out in their Will or trust deed.
- Determine how to invest or use the trust’s asserts.
There must always be at least one trustee.
Beneficiaries: this is the person or persons who will gain the assets placed into the trust. They may benefit from:
- The income and capital of the trust.
- The income from a trust only, for example if a house held in a trust is rented out.
- The capital only, for example getting shares which are held in a trust when they reach a certain age.
Types of trust
There many different types of trust, some of which overlap: a trust may actually fit the description of more than two apparently alternative types of trusts.
Trusts can be classified using a number of alternative methods or elements. The element may be:
Character: a charitable purpose trust (also known as a public trust, whereby the beneficiary firmly fits in four charitable categories) or a non-charitable purpose trust (a private trust whereby the beneficiary may not be an ascertainable person)
Disbursement: a protective trust (where the settlor is also a beneficiary) or a qualifying trust (where the settlor is not a beneficiary).
Revocability: a revocable trust (where a settlor keeps ownership and control of trust property and may alter the trust deed at any time) or an irrevocable trust (where the settlor is not able to alter or make any amendments to the trust deed)
Establishment: an express trust (whereby the settlor creates or establishes the trust) or one that is imposed by law (sub-types include statutory trusts, resulting or implied trusts, and constructive trusts).
The most common type of trust used in the UK is the express trusts. As such, this is what we will discuss in more detail:
Bare, simple or absolute trusts
- As a settlor of a trust, you must transfer assets to the trust, appoint trustees, specify the beneficiaries and declare that all the assets should be passed directly to the intended beneficiaries.
- The trustees accept ownership of any transferred assets
- The beneficiary or beneficiaries are entitled to, and have absolute right to, all of the capital and the income that is gained or within the trust at any time (so long as they are over 18 years of age in England or Wales or at least 16 in Scotland).
Normally, it will not be possible to amend the beneficiary(s) once the bare trust has been established.
Simple trusts are most frequently used to transfer assets to minors (individuals who do not meet the age requirements as specified above)
If you intend on disbursing assets in a trust to multiple beneficiaries in specific allocations, you may use a deviation of a simple trust called a fixed trust. Fixed trusts retain all the other characteristics of absolute trusts. In addition, it is not obligatory that the value of the trust property is known.
Interest in possession trusts
These are trusts where the trustee is required to pass on all trust income to the beneficiary as it arises (less any expenses).
An income beneficiary eligible to income for as long as they are alive is called a 'life tenant', and the trust is titled a ‘life interest trust’.
These types of trusts are often used to provide for a surviving spouse. The capital of the trust is kept from being deployed and passed on to heirs (normally children) when the spouse passes away.
This is a type of trust where the trustees are able to make certain choices about how to use the trust income, and occasionally the capital.
Subject to the trust deed, trustees can determine:
- The amount that gets paid out (capital or income).
- Which beneficiary to make payments to.
- The frequency of the payments.
- Any conditions for which to impose upon the beneficiaries.
Typically, these types of trusts are established for a future need, such as a grandchild that may need additional financial support in the future or beneficiaries who may not be capable or responsible enough to deal with money by themselves. The latter is often referred to as a trust for vulnerable beneficiaries or trust for disabled beneficiaries. You may set this up for a beneficiary who might be physically or mentally disabled. This type of trust has special tax exemptions.
A mixed trust includes characteristics of a number of different express trusts. In other words, it does not precisely fit the description of only one type of trust. Mixed trusts show just how flexible UK trusts can be. As such, tax rules for a mixed trust can vary.
These types of trusts may be established when you intend for relatives of varying ages (who meet the age requirements at different times) to benefit from the same trust fund.
This type of trust is where the settlor or their spouse (or civil partner) benefits from the trust. The trust could be:
- An interest in possession trust.
- A discretionary trust.
- An accumulation trust.
These types of trusts are often used if an injury or illness hampers one’s ability to work, creating a discretionary trust is a smart way to safeguard against financial demise in the future.
This is a trust where the trustees are not residents in the UK for tax purposes. As such, the tax rules for non-resident trusts are extremely complicated.
Charitable purpose trusts
Charitable purpose trusts meet at least one of the following four criteria to be classified as such:
- Relief of poverty.
- Advancement of religion.
- Advancement of education.
- Other purposes that are beneficial to the community.
These types of trusts have favourable tax rates applied to them.
Set up a trust fund
An express trust must be validly declared in the UK according to case law.As such, it must establish three certainties:
- Certainty of intention: an individual clearly intends to create a trust.
- Certainty of subject matter: an individual plainly and precisely defines the trust property.
- Certainty of objects: an individual unequivocally delineates the beneficiaries.
Prior to arranging assistance to establish the trust, you may:
- Identify the assets you would like to be placed into the trust.
- Decide upon the trustees that you would like to appoint to manage the trust.
- Specify the beneficiaries for the trust.
- Make a concise outcome of the terms.
You will need the assistance of an expert with specific skills and knowledge in the fields of law, finance and taxationto help you set-up the trust.