What is a trust?
A trust is a legally binding contract in which ‘trustees’ are given legal responsibility to look after assets, for example, property or land. Items such as antiques and jewellery can also be placed in a trust or otherwise known as ‘chattels’.
‘The settlor’, is the person who set up the trust; they own the assets within the trust. The settlor can inform the trustees of what they can do with the assets and also can control who should benefit from the trust; these people are ‘beneficiaries’.
What are trustees?
Trustees not only have to carry out the duties that the settlor has outlined, but they also have to manage the trust on an everyday basis, paying tax that is due, and they decide how to invest in the assets. Typically there are two trustees. Usually, the trustees are a lawyer and a family member.
What are the beneficiaries?
Beneficiaries usually receive some benefit from the trust. They may benefit from income from investments or property lets, or they may benefit from the capital.
What are settlors?
Settlors are people who create the trust and acquire assets to put into the trust, usually referred to as ‘settling’ property. The settlor will add the assets to the trust once they have established the trust. The settlor can also add assets to the trust at a later date. Settlors control what happens with the assets in the trust, and they direct the trustees on what they should do. Settlors can also be beneficiaries in as well in some cases.
What types of trust are there?
Each trust can serve completely different purposes. Some trusts may prevent young people from accessing money from the trust before they are old enough. The range of trusts available is vast, and each has different tax benefits and pitfalls. It could be useful for you to discuss this with a financial advisor before you commit to a trust.
1. Bare trust
With a bare trust, the beneficiary is entitled to the capital (the original asset) and any interest that the unique asset makes. If the recipient of the trust is an adult, they can have access to the capital and interest whenever they choose. If the recipient is under 18, the trustee must hold on to the assets until the beneficiary reaches 18.
Although you may know whom to pay the money and interest to, a bare trust allows the beneficiary to make use of the assets whenever they choose. Another disadvantage is that once you have decided who will benefit from the trust, this cannot be changed, so if you decide you want to cut ties with that person, you cannot stop them from collecting their cash.
Tax on bare trusts
The beneficiary has to pay any income tax on any income they receive from the trust. You can add this to the income they may earn or be a recipient of the outside of the trust. You must declare income received from the trust by filling out an SA100 Self-Assessment Tax Return form.
You should expect to have to pay Capital Gains Tax if you sell the assets within the trust after being put in the trust. The assets within a bare trust act as if the beneficiary holds them, for tax purposes. The beneficiary must pay capital gains tax.
2. Interest in possession trust
This type of trust gives the beneficiary full access to all of the income the trust earns, but they do not have any rights to the capital. Separate recipients can then receive the money. For example, a wife may set up an interest in possession trust and may assign her husband to be beneficiary of the trust. He can benefit from the income in the trust, but when the husband dies, their children will benefit from the capital from then on. Some trusts may allow an income beneficiary also to be a recipient of the money, the right to live in a house that is non-incoming-producing.
Tax on interest in possession trusts
Trustees are responsible for paying income tax and also capital gains tax on the trust. Trustees must fill out a Trust and Estate Tax Return each financial year to declare income tax. The rules around interest in possession trusts are complicated. There are different rates of income tax which is dependent on how you acquired the money. There are also special rates for beneficiaries who have disabilities or for under 18’s whose parent has passed away.
3. Discretionary trusts
Discretionary trusts give much more power to the trustees. The trustees’ discretion’ is to decide how to run the trust, how to make the best use of the trust’s income. They can also determine how to distribute the assets in the trust. As well as this, trustees have the power to decide who can receive income and capital. They can determine how much and whom you can pay the income and wealth to. They can choose how often the payments are made and can impose conditions on the beneficiaries of the money. Sometimes this can come across as the trustee’s having too much power, especially if you are a beneficiary. However, a trust like this is useful if one beneficiary needs more financial assistance than others.
4. Accumulation trusts
Accumulation trusts are quite similar to discretionary trusts. Trustees have the power to utilise the income and capital to create more wealth and can add it to the actual money for the benefit of the beneficiaries. The beneficiary is entitled to both the original capital and the ‘accumulated’ capital. Up to where that child reaches that age, the trustees have full control of the assets in the trust. They can decide whether they should pay income to the beneficiaries.
Tax on discretionary and accumulation trusts
It is the trustee’s responsibility to be declaring and paying income tax on the income earned by the trust throughout that financial year.
You will have to pay tax on income at a special trust rate, the first £1,000 of income earned is typically taxed at a lower price. The tax rate can also depend on how you made that income. The income of £1,000 and under, you may have obtained from rent, trading or savings usually are taxed at 20%. If you earned the income from UK dividends, you would have to pay tax at 10%. Any income over the £1,000 band, for example, dividends and distributions are taxed at 42.5%. Any other income, you will have to pay tax at 50%.
When the beneficiary receives the money from the trust, the funds will have to be paid tax at 50%. Beneficiaries can sometimes claim back some tax depending on the income tax rate they are currently paying. If there are capital gains that you have made in the trust, the trustees must pay any tax due.
5. Settlor-interested trusts
A settlor-interested trust is a trust where the person who sets up the trust can also benefit. If you are the settlor or legal spouse/civil partner of a settlor who is also a beneficiary, you may be able to ‘retain an interest’ in the trust. HMRC states that any settlor-interested trusts are not trusts in their own right but can either be a type of interest in possession, accumulation or discretionary trust.
HMRC outline what these different things mean:
- Interest in possession: this is where the settlor, their spouse/civil partner may be entitled to all the income.
- Accumulation: trustees can retain and add revenue to the capital on behalf of either the settlor, their spouse or civil partner.
- Discretionary: any trustees can make payments to the settlor, their spouse/civil partner.
Tax on settlor-interested trusts
The settlor has the responsibility of paying the income tax on any of the income received from the trust, even if you do not pay the money out. As trustees receive their income, they must pay tax through a trust and estate tax return. Where assets in the trust may have increased in value above the capital gains annual exempt amount, the settlor is held responsible for paying any of the capital gains tax that is due.
Parental trusts for children
Parents are also able to set up trusts for their children who are under the age of 18. The children must have never married or been in a civil partnership. Parental trusts are not necessarily trust in their own right, but they can be a form of any of the above listed settlor-interested trusts, but this is depending on how much freedom the parent would like the child to have with the money.
Can anyone set up a trust?
Yes, anyone can set up a trust. Often the costs of doing this are restrictive, and it is sometimes not worth doing unless you have money saved that you would like to ring-fence. It would help if you did not let the idea of trusts being for the wealthy put you off. Many people make gifts through trusts as you can avoid inheritance tax or they use trusts to split up an estate.
Are you considering setting up a trust fund? If so, you may need help with setting one up, due to its complex nature. You may find that all of the different options available to you are a bit overwhelming. We have friendly, understanding expert Solicitors on board to support you with the process.
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