Trusts are one of the most valuable financial planning tools but they are also one of the least well understood. Here, we explain what a trust is and why they are used. We then look at some of the different types of trust and how they work.
What is a trust?
A trust is similar to a treasure chest – it’s a safe, locked box holding valuable contents for somebody else’s benefit. The person who wants to set up the trust puts cash or other assets into the treasure chest and locks it.
The keys to the treasure chest are held by trustees (usually including the person who sets up the trust). The trustees can unlock the treasure chest, change the assets inside and distribute the contents in line with the terms of the trust.
Who is involved with a trust?
There are three key roles within a trust – the settlor, the trustees and the beneficiaries.
- The settlor
The settlor, or truster in Scotland, is the person who establishes and puts assets into the trust. Settlors are usually individuals or couples.
- The trustees
The trustees are the people who control and oversee the trust. Anybody can act as a trustee as long as they are over 18 and have full mental capacity. Often the settlor will act as a trustee to keep an element of control over the trust.
- The beneficiaries
The beneficiary of the trust benefits from the arrangement. For example, they may receive money from the trust or the right to occupy a property. Certain trusts give the trustees discretion over how and when these benefits are given to beneficiaries.
The different types of trust
There are many different types of trust, each with different purposes and tax rules. Some of the most common types of trusts are:
- Absolute or bare trusts
- Interest in possession trusts
- Discretionary trusts
- Loan trusts
- Discounted gift trusts
- Discretionary will trust
- Life interest will trust
Reasons to set up a trust
A trust lets you keep control over the assets you place in it. A common example is when somebody marries for the second time but has children from a previous relationship. Usually, they want to ensure their second spouse is taken care of for the rest of their life, after which the money will pass to their children from the previous relationship. A trust lets them do this.
Trusts offer a means of protecting assets for the beneficiary. An outright gift given to a beneficiary who then divorces or goes bankrupt could be lost. However, if a gift is made into a trust under which a beneficiary has no right to the income or capital, then that gift is much less likely to be taken into account during divorce or bankruptcy proceedings.
Saving inheritance tax
Trusts offer a useful way to save inheritance tax without having to make an outright gift to another person. If you place assets into a trust to which you cannot benefit, after seven years the assets will fall outside your estate for inheritance tax purposes. Any growth on the assets will immediately be outside your estate.
Avoiding probate delays
Usually, after you die any inheritance tax and probate fees must be paid before your assets can be distributed in line with your Will. However, the executors of your Will can’t access your assets until probate is granted – so they must find the money from elsewhere. As a trust is separate from your estate, your trustees can immediately access any money held in it and use the money to pay the inheritance tax bill and probate fees.
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