Types of Trust (UK specific) explained, and why they are used

Trusts are something that people often get worried about – they think it’s all too complex and not for them.  But basically it’s about putting a defined amount of money (or other assets) under someone else’s control for the benefit of defined group of people (and you choose who those people are).  The person who is listed as the owner is not necessarily entitled to the money themselves, but is looking after it for others.  They are entrusted with its care. 

This is written about UK trusts, but they can exist in other forms in other countries in the world. The choice of trust is important, as there can be adverse tax consequences if you are using the wrong type for the task in hand. This short post is not a substitute for specialist legal advice tailored to your circumstances.

Why would I need one?   

You might be using a trust structure without realizing it – now!  If you and your partner own a house together, then you might both be listed on the deeds.  When you sell, do you each get half of what is left over after expenses?  If you died, would you want your partner to automatically have all the value in the house?  How have you decided the terms of your house ownership with each other? 

If you have a child who is under the age of 18 when you die – who will look after the assets you have on their behalf until they are old enough?  Is 18 old enough to inherit what you have?  Do you have a child who has additional needs?  Do you want them to have all your money when their needs might be lifelong, and they might not be able to manage money well? 

Do you worry about what might happen if your partner meets someone new and forgets about how much they have inherited from you – and spends it on them?  Or if they get into debt, and it eats up not only all their share, but yours as well?  A trust can be a good way of letting your partner have some of the benefit of what you have, but keeping a bit of security, so they don’t spend it (or have it spent for them) 

Are they expensive? 

There will be a cost for setting up your trust.  Running a trust can cost, but then again, if you choose non-lawyers or non-accountants to be your trustees, the cost may be minor, being limited to out of pocket expenses.  Looking after a million pounds means more work to do than if you were being asked to look after a thousand pounds, and you might need professional help.   

Apart from working out what sort of trust suits you and getting the right sort of trust in the beginning, making it work will require some effort, just like running a car or getting a regular haircut. 

Will I need a lawyer all the time? 

Probably not, if you still have an idea of what the responsibilities of a trustee can be.  However, if you are worried, then legal advice is available, if your trustees want to know more.  It can be necessary to have an independent person as a trustee – a friend or someone outside your closest family. 

You mean there are different sorts of trusts? 

Yes – there used to be many more types of trusts – and confusingly, not everyone talks about them using the same labels.  Basically, trusts now can be broken down into four types: 

1. The bare trust 

2. The Interest in possession trust 

3. The discretionary trust 

4. The charitable trust. 

A bare trust is similar to a nominee – you decide that someone is to own the asset in name only.  But you expect that the proceeds of sale will not go to the person who appears to own it, but to your choice of recipients 

An Interest in possession is where a named person is entitled to receive the income (or to live rent free) in an asset.  The capital remains safeguarded.  Some sub-types of this sort of trust can also be chosen.  These are usually set up in a will, to take effect after death, for tax reasons. 

A discretionary trust is one where you place the most trust – because it is the most flexible arrangement.  You give your assets to your trustees, identify the people who you want to benefit, and then leave the management of the trust, including how and when people benefit to your trustees.  It is helpful to leave them some written guidance, so that they know what you have in mind – but ultimately, you give them the authority to do the “right thing” with your assets, for the benefit of those whom you have chosen.   

So, a bare trust is quite simple? 

Yes – it’s the sort of thing you have if you purchase a house for a person under 18 – when they turn 18, they can force the trustee to hand it over.  You find this sort of thing when administering an estate – an executor, once they have paid debts, can say that they are holding assets for your benefit – and sell on your behalf, at your direction.   

Interest in Possession sounds really weird… 

This is one of the sorts of trusts that ends up with lots of different names, because the technical name is not really all that catchy.  Sometimes it’s called a property trust – because it’s often used to safeguard a share of the house for the benefit of the surviving member of a couple, so they can continue to live in a house rent free, but without being able to spend it on someone new.  Other names can be “Life Interest Trust”, “home trust” and so on – sometimes there are advisers that use this structure and want to brand it specifically so that it has more appeal.   

Discretionary Trusts sound so complicated.  Why would anyone want them? 

These are the most flexible sort.  If you have a person with a learning disability, they may need money throughout their lives, but may not be able to make significant financial decisions either now or in the future.  They may be able to live independently, but be easily swayed by people who want to take advantage.  They might have a physical disability that could need more and more care as time goes on.  Choosing a discretionary trust structure allows those in charge of it (trustees) all the power they need not only to invest according to the needs of those who benefit, but also to pay out in all sorts of different ways – as and when needed.   

It is true to say that Discretionary Trusts are used in times of uncertainty, for those who are wealthy and who want to pass on money for tax reasons, perhaps for their children not to receive the money too soon, if at all.  Or for business owners who want there to be only a few people that own a block of shares, rather than lots of minor shareholders clamouring for power.  But essentially the structure is the same – two trustees who look after something for the benefit of a range of people.   

You left out charities!

Well, there are not many people who want to set up charities – usually there is a charity to suit every need in existence already.  Sometimes using an existing charity presents the best value for money for those who are in need – saving on set up costs and running costs.  Charities can be made using trust documents, setting out their objectives and who is proposed to benefit.  Similarly, pension fund trusts are less often the creation of an individual – and pension fund trustees have wide powers over what they do to invest, and distribute. 

What else do I need to think about? 

Taxation is something that can come into your decision making process.  If you give a property away, there might be a Capital Gains Tax bill – but your advisers might have a way of postponing this.  If you have a fund larger than £325,000 initially, then there are other considerations for Inheritance Tax.  Inheritance Tax capital gifts also have fairly strict allowances – otherwise they might be a gift that you need to survive by a period of years (7 years to a maximum 14 years from trust gift). As with all Inheritance Tax gifts, you cannot benefit from what you have put into your discretionary trust, or it will not work ⁽¹⁾

During the lifetime of the trust, the size of the fund and how it is invested can be important – because it means there will need to be more financial housekeeping.  This can be a relevant consideration in many cases.   

What do you recommend? 

It depends on what matters the most to you – behind every choice there is a risk and benefit.  There is not really a one-size-fits-all solution for every circumstance, and that is where the advice from your solicitor (or accountant) about a trust can be so beneficial.  For more in –depth analysis of the structures you would like to use, and their implications for your own financial situation, you should consider this general note with tailored advice to suit you. 

(1) There are exceptions to this rule, but only very few. Tread carefully, with advice.