Insights

In this insight, we look at trusts. These can be a useful tool in planning for the future, but their rules and uses are complex and can often be misunderstood. Here, we set out the essentials.

What are trusts?

Essentially, trusts are an arrangement where the original owner (known as the “truster” or “settlor”) transfers cash or other assets to one or more people (the “trustees”). The trustees are responsible for holding and managing the trust assets for the benefit of another group of people (the “beneficiaries”).

Trusts can be set up during lifetime, but it is also common to include provisions within Wills that establish a trust on the settlor’s death.

What are the benefits of a trust?

Trusts come in many shapes and sizes, but the key advantage is that they separate the ownership and control of an asset from the person or people who are to benefit. This can be useful where there is reason to avoid a beneficiary owning the assets outright, for example, due to their age.

Those included as potential beneficiaries can be a very wide category. In many types of trust, beneficiaries have no fixed entitlement to the trust assets. This means that options can be kept open as to who exactly is to benefit, and in what way.

Uses for trusts

There are many circumstances in which trusts can be useful. Situations encountered commonly include:

• Where beneficiaries are currently too young to manage the assets themselves. This can be the case for trusts set up during a person’s lifetime but is also very commonly encountered in Wills. With Wills, it is unclear how old the beneficiaries will be at the time they come to inherit. As such, provisions are included in the Will so that a beneficiary’s inheritance is held in trust in the event they are under a certain age at the time of the settlor’s death.
  
  
• Where the intended beneficiary is in receipt of means-tested benefits. Transferring assets directly to such a person could result in them losing their entitlement to their benefits. Once lost, these can often be very difficult to recover.
  
  
• In care home fee planning. It is increasingly common for people to be concerned about protecting their homes, in case they require care in the future. While there can be no guarantees with this type of planning, many people elect to transfer their home into trust in an attempt to shield it from a financial assessment for care.
  
  
• As part of Inheritance Tax (“IHT”) planning. Broadly speaking, IHT is charged on the value of assets a person holds on their death. However, the value of anything gifted within the seven years prior to death is also included (subject to various exceptions). As such, the sooner assets are transferred out of a person’s ownership, the more likely they are to avoid being subject to IHT. Trusts can be helpful here, since they allow the transfer of assets while the intended beneficiaries are young, or where the truster has not decided who exactly is to benefit.
  
  
• For Capital Gains Tax (“CGT”) planning. Many people are unaware that CGT can become payable on gifts, as well as the sale of capital assets. Often, people are put off gifting assets such as properties and shareholdings because their value has increased significantly since they were acquired.  Where this is the case, CGT would be payable on the gift. However, certain rules apply to transfers into trust that can be used to avoid this situation arising.
  
  
• Trusts can be used to hold funds received in compensation for a personal injury.
  
  
• Charities can be established as trusts.

Considerations

While trusts can be incredibly useful, they are not the solution to all legal issues.  When considering use of a trust in a particular situation, it is worth considering the following:

• Suitability for meeting your goals. As noted above, trusts can be structured in many different ways.  What is suitable will depend on the settlor’s goals. For example, if you wish to transfer their property into trust for care planning purposes, they must name yourself as a beneficiary of the trust in order to continue living there. However, retaining the benefit of living in the property will make this type of trust ineffective if IHT mitigation is the goal.
  
  
• The settlor’s ability to part with the trust property. In most cases (particularly where IHT planning is a goal), it is important that the settlor derives no benefit from the assets that are transferred into trust. It is therefore important to ensure that there is no possibility that you may need the funds or other assets, either now, or in the future. If a house is to be transferred, it is essential that there is no mortgage on the property – a lender will not agree to the transfer if there are funds outstanding to them.
  
  
• Tax. Trusts are subject to their own taxation regime, which can be complex. While trusts can solve many tax problems, care must be taken to ensure that no issues are caused inadvertently.
  
  
• There are also various compliance requirements to consider, such as a duty to meet (typically this is done annually) and potentially a requirement to prepare an annual tax return and account. We can guide you through the requirements here to ensure nothing is missed.

Conclusion

Many people are nervous of using trusts but used appropriately, they can solve many personal legal and tax problems. However, they are not without their pitfalls and are not the solution to every issue. As such, expert advice should be sought before deciding to proceed with trust creation. 

If you have any questions, please contact our Private Client team who will be happy to assist.

Further reading: Do you have a Will? Find out why it’s important to put one in place and keep it updated here.
Further reading: Trusts and Succession (Scotland) Act 2024 – learn more about the changes and what these mean for you here.