Locking your money away in different trusts

Phil Carroll goes through the different types of trusts available

There are a variety of trusts available in the market place but it is important to understand the main principles of a trust in order to develop opportunities in this area. There are many reasons to use a trust and a number of ways that a trust can be set up to meet the exact needs of the client. It is in this advice process that the value of the adviser is readily seen.

If you are cynical about the changes the Government has made in this area in recent years, you may think trusts exist simply to help avoid paying tax. However, historically, trusts were used to protect ownership of land and assets while individuals were away fighting the crusades. Clearly tax is a key consideration when discussing trusts but for some clients it will not be the sole driver.

The legal definition of a trust is: a fiduciary relationship in which one person (the trustee) holds the title to property (the trust estate or trust property) for the benefit of another (the beneficiary).

Principally, the trust enables the transfer of ownership of an asset from one party (the settlor) to another (the trustees) for the benefit of someone else (the beneficiary).

As the definition states there are three key components to a trust - the trust property, the beneficiaries and the trustees. However, initially the most influential party in the arrangement will be the individual creating the trust - the settlor.

Meeting the settlor's wishes

Upon the asset being placed under trust, certain rights or restrictions created within the wording of the trust may detail how the property is managed in the future. Contingencies may also be included, from the straight forward - receive the whole trust fund upon obtaining the age 30 - to the more obscure - an income for life so long as you never smoke!

These clauses are designed to reflect the settlor's wishes. Unfortunately without appropriate trustees, the settlor's wishes can be overlooked as issues such as where to invest the monies or minimising tax are pushed to the forefront. Meeting the settlor's wishes can be easily achieved with the right trustees and with good financial advice to hand. An adviser can help demonstrate how trusts can be used in line with the settlor's wishes and with tax efficiencies in mind.

Personalising a trust

A trust should ultimately enable the settlor's wishes to be met during and after his lifetime. Modern family lives are now more complicated than ever with the rate of divorce, second marriages and second families seemingly on the rise. A trust can offer a useful tool to ensure that family members are taken care of should anything happen unexpectedly.

For a younger client, ensuring sufficient capital and income can be provided to dependents should death strike early, can be catered for by using suitable protection policies and a trust. A trust will also enable a grandparent to reduce their inheritance tax liability while providing a grandchild with significant funds on either a regular or adhoc basis. Regular payments may prevent them from spending a cash lump sum on fast cars, wild relationships and illegal substances.

Creating effective trusts should come after establishing up-to-date, valid wills. Without a valid will, an individual's estate will be subject to intestacy rules and therefore eligible for assets to be distributed to individuals who the settlor may not want to benefit from the estate. Assuming valid wills exist, the grant of probate, which is issued to the legal personal representatives of the estate who have proved and registered the will with the courts, can not be issued until inheritance tax (IHT) has actually been paid. When the main asset is the family home, this may cause problems and the need for advice in this area alone is compelling.

A trust can offer clarity over both these points as assets under trust do not generally require probate nor are they affected by the requirement for a valid will but this will only relate to the assets under the trust and not the individual's entire estate.

Trustee responsibilities

It is the role of the trustees to deliver the settlor's wishes and ensure an equitable position for all the beneficiaries involved in the trust. Some beneficiaries may only be entitled to income and others to capital.

Consider John, he has two sons from a previous marriage and is now married to Christine. In the event of his death, John would like Christine to continue to enjoy a good standard of living. However, on Christine's death John would like the remaining capital to be paid to his two sons. How the trustees manage John's assets is important. Christine may demand the maximum income possible but this could mean capital is exposed or future growth forgone in this approach. The two sons may well look to challenge the trustees' investment decisions now or in the future. This highlights the need for clear instructions from the settlor and careful consideration on the appointment of trustees.

Trustees are bound by legislation (in England the Trustee Act 2000) which outlines the key responsibilities for trustees including such areas as duty of care, powers of investment and definition of proper advice. Linking all three areas to the investment and management of assets means that most 'lay' trustees will seek professional help in selecting and managing investments - a key opportunity for advisers. Cowen v Scargill and Nestle v National Westminster Bank are just two court cases underlining the need for professional support around investments. Alternatively, a professional trustee service could be used to provide an unbiased approach and avoid many of the conflicts that family members acting as trustees can encounter.

Bare and discretionary trusts

There are several types of trust available. However, they are differentiated by the beneficiaries and what rights, if any, are retained by the settlor under the trust. A trust where there are specific named beneficiaries who cannot be varied is likely to be called a bare or absolute trust. While a trust that leaves the beneficiary class much wider and variable, catering for a class of beneficiary, born or unborn, is likely to be called a discretionary trust.

A bare trust offers certainty of the beneficiary and creates a potentially exempt transfer where the gift is not already exempt, thus avoiding any entry, exit and periodic charges relating to inheritance tax. Additionally, a bare trust enables the beneficiaries to utilise their own capital gains tax allowance on any gains realised inside the trust and not be limited to the trustee annual exemption which is half the value of the personal annual exemption. However, the asset immediately forms part of the named beneficiary's estate and, should the beneficiary die, the asset will be subject to IHT. Also, from an income tax perspective, where the gift is from parents to unmarried minor children and the income exceeds £100 each, it will be assessed back on the parents and not the child.

A discretionary trust avoids the IHT implications but is subject to entry, exit and periodic charges. The wide class of beneficiaries adds flexibility as most would cater for those born or unborn, such as future grandchildren at the time the trust was established. Careful planning around the IHT nil rate band can mean entry, exit and periodic charges can be reduced or negated. Again, advice is critical here, especially where using both types of trust at the same time.

Often the settlor may wish to 'carve out' an interest in the asset. This could be a right to a regular payment or percentage of the overall asset gifted as not everyone can afford to give all their money away unconditionally. This could be used to create an income or safety fund should a lump of capital be required. However, there are many rules which need to be adhered to when creating such interests and again, these mainly relate to tax.

Need for advice

These principles underpin most trusts but variations exist to create and meet different needs. There are many types of trust available but once the core principles are understood, it is the variations which will enable the adviser to add value in the advice process. Meeting client objectives and providing peace of mind for clients is one thing, achieving this with added tax and wrapper flexibility is another. The opportunity to advise on existing trusts as well as new ones clearly demonstrates that investing time and resources in this area should pay handsome dividends in the long run.