8 of the Most Common Questions about Trusts and Trust Funds

These are the most important questions about trusts to help you organise money, protect your assets and save tax

Trusts and trust funds are important legal and financial tools that can help individuals and families achieve a variety of objectives. Whether you are looking to protect your assets, provide for your loved ones, or support a charitable cause, a trust may be the right choice.

However, these complex structures can be confusing and intimidating, with many people having questions about how they work and what they can do. These are the five most common questions:

1. What is a trust?

A trust is a way of holding assets to benefit someone (known as a beneficiary) without that person owning and controlling the assets themselves. The assets within the trust, known as the trust fund, are managed by trustees for the benefit of the beneficiaries.

The trust is set up by an individual referred to as a settlor, who will decide what type of trust to create, how the trust fund will be used, and who the beneficiaries will be. Most frequently, trusts are set up in Wills. There are different types of trust, one of the main types being a discretionary trust, in which the trustees have the authority to apply trust funds as they deem appropriate.

Trust assets aren’t limited to cash; they can also include property and shares.

2. Why create a trust?

Trusts can help avoid probate, reduce inheritance tax, protect assets from creditors, and ensure assets are distributed according to the settlor’s wishes. Trusts also offer privacy since they don’t usually go through probate, making them less public.

Creating a trust allows you to help your beneficiary manage their assets. Some common reasons include:

• To manage assets for a beneficiary who is under 18 or who cannot manage their own affairs
• To benefit individuals while also protecting assets from being lost, for example, because of bankruptcy, divorce or mismanagement
• For tax reasons.

3. How do I set up a trust?

Setting up a trust involves several key steps and requires careful consideration to ensure it meets your specific goals. Here’s a quick guide to setting up a trust in the UK:

 Define your objectives

• Determine why you want to set up a trust. Common reasons include managing assets for minors, providing for vulnerable beneficiaries, protecting assets from creditors, estate planning, and charitable giving.

Choose the type of trust

• Decide on the type of trust that best suits your needs. The main types include:
  • Bare trusts: Beneficiaries gain immediate control at age 18.
  • Discretionary trusts: Trustees have discretion over who benefits and how much.
  • Interest in possession trusts: Beneficiaries have the right to income, but not necessarily the capital.
  • Charitable trusts: For philanthropic purposes.
  • Special needs trusts: For beneficiaries with disabilities or special needs.

Select trustees

• Choose trustworthy and competent individuals or a trust professional such as a solicitor to manage the trust. Trustees are responsible for managing the trust’s assets and making decisions in the best interest of the beneficiaries.

Draft the trust deed

• Work with a solicitor to draft a trust deed, which is the legal document that outlines the terms of the trust. The trust deed should include:
  • The names of the settlor(s), trustees, and beneficiaries.
  • The type of trust and its purpose.
  • The assets being placed in the trust (the trust fund).
  • The powers and duties of the trustees.
  • Any specific instructions or conditions, such as how and when the assets should be distributed.

Fund the trust

• Transfer the assets into the trust. These assets can include cash, property, investments, or other valuables. The transfer process will depend on the type of assets involved and may require valuation and legal documentation.

Register the trust (if necessary)

• In the UK, some trusts must be registered with HM Revenue & Customs (HMRC), especially if they are liable to pay tax. The registration process involves providing detailed information about the trust, its assets, and its beneficiaries.

Consider tax implications

• All trusts carry tax implications, including income tax, capital gains tax, and inheritance tax. It effects all trusts differently. It’s crucial to understand which tax rules apply before you create the trust. Consulting with a tax advisor is advisable to ensure compliance and optimise tax efficiency.

Maintain and administer the trust

• Trustees are responsible for the ongoing administration of the trust, including managing the trust assets, filing tax returns, keeping records, and making distributions as outlined in the trust deed. There are a lot of statutory requirements and legal obligations imposed on trustees, so they need to know what they are doing — or get professional advice — or else they could end up with personal liability for the trust losses and the legal costs arising from a complaint and/or their removal as a trustee. Regular meetings and communication with beneficiaries may also be required.

Review and update the trust

• Trusts should be reviewed periodically to ensure they still meet the settlor’s objectives and comply with current laws. Trustees are legally obliged to keep investments under regular review. They should prepare annual accounts and (depending on the type of trust) regularly review how it interacts with the beneficiaries. Changes in family circumstances, financial situations, or law may necessitate reviews to make sure the trust is being properly managed.

Seek professional advice

• Setting up and managing a trust can be complex. The ongoing obligations of trustees are numerous and onerous and they have lifelong liability for any mistakes made. So It’s advisable to seek advice from a solicitor specialising in trusts and estate planning, as well as a tax advisor. They can provide guidance on legal, tax, and practical matters, ensuring the trust operates effectively and legally.

By carefully planning and following these steps, you can set up a trust that effectively manages and protects your assets according to your wishes.

4. What is the difference between a bare, absolute and discretionary trust?

Bare trust: In a bare trust, the trustees must look after the assets until the beneficiary attains 18. Then, the beneficiary has complete control over the trust assets and income. The trustee has no discretion over managing or distributing the assets and must follow the beneficiary’s instructions. This type of trust is often used for simple arrangements where the beneficiary is a child.

Absolute or life interest trust: An absolute trust gives the beneficiaries some protection from creditors or legal claims against them. The trustee has some discretion to manage the assets, but the beneficiaries have an absolute right to receive them at a certain age or on a specific date. This type of trust is often used for estate planning and protecting assets from potential creditors.

Discretionary trust: A discretionary trust gives the trustee control over distributing the assets among a group of beneficiaries. The trustee has discretion over who receives what and when. This type of trust is often used for asset protection, estate planning, and for beneficiaries who may be unable to manage the assets themselves.

These are the three most common types of trusts. For more information about other types of trusts available, visit our Trusts webpage.

5. Who owns trust property?

The trustees are the legal owners of the trust property; however, strict regulations set out how they can deal with this. Trustees should be reliable, capable, and able to manage the trust’s assets according to the trust deed. They can be individuals or professional entities, and selecting someone with the appropriate skills and experience is important.

A trustee’s responsibilities include:

• Following the terms of the trust document
• Acting reasonably and fairly towards the beneficiaries and taking into account the needs of them all, although this does not mean all beneficiaries have to be treated in the same way
• Avoiding any conflict of interest
• Not profiting from the trust
• Not delegating their powers except as allowed by law
• Exercising reasonable care and skill
• Keeping accurate records
• Informing adult beneficiaries of the trust and their interest in it, unless the trust is discretionary.

Trustees should follow the terms of the trust, exercise independent judgment, and always act in the best interests of the beneficiaries.

The trustees may have been given a letter of wishes by the settlor, which can guide them in their decision making, although this will not be binding.

6. When will I inherit the capital in a trust?

Whether you will inherit the capital in a trust and when this will happen depends on the trust.

If you are the beneficiary of a bare or absolute trust, the trust document will generally set out the age at which you are to inherit.

If the trust is a life interest trust, then you will be entitled to the benefit of the trust assets during your lifetime, and on your death, the capital will pass to the person chosen by the settlor.

If the trust is a discretionary trust, then the beneficiaries do not have a right to the capital. The trustees may decide to end the trust at some point, for example, if funds have dwindled or the trust has served its purpose, such as paying for the education of the beneficiaries. If the trustees do decide to terminate the trust, they will distribute the capital to the beneficiaries as they see fit.

7. What rights does a trust beneficiary have to trust funds?

Under a trust, beneficiaries do not have any rights to the trust funds unless the trust deed says they have rights. The trust deed will set out if and how the trustees can award money and to whom.

Under a bare trust, named beneficiaries are entitled to all the trust capital and income when they attain 18. Under an absolute trust, the beneficiary will receive the capital at the specified age, which can be 18, 21 or older.

Trust beneficiaries are entitled to be told of the existence of a trust and the type of interest they have in the trust assets, which could be a fixed interest, an interest in the remainder or a contingent interest.

Those named as beneficiaries in discretionary trusts are only potential beneficiaries, as there is no legal requirement to pay trust funds to them. This means they do not have to be told of the trust’s existence unless they are likely to benefit from it.

Beneficiaries can also expect to be informed who the trustees are, to include any new appointments and to be provided with trust accounts showing the extent of the trust fund.

Beneficiaries are not usually entitled to see letters of wishes, communications between trustees, communications with other beneficiaries or information about trustee meetings.

8. How are trusts taxed?

The taxation of trusts involves several key considerations, including income tax, capital gains tax, and inheritance tax. Here’s a general overview of how each type of tax applies to trusts, but it is crucial that you get specific advice from a solicitor tailored to your trust before you make or decide not to make any decisions:

1. Income tax

a. Trust income

• Trusts are taxed on their income in different ways depending on the type of trust.
  • Discretionary trusts: Income is taxed at a special trust rate, which is higher than the basic rate for individuals. As of the 2023/24 tax year, the rates are:
    • Basic rate income: 45%
    • Higher rate income: 38.1%
    • Additional rate income: 39.35%
  • The trustees pay tax on income not distributed to beneficiaries. If income is distributed, the beneficiary might be taxed on it instead but can usually receive a tax credit for the tax already paid by the trust.
  • Interest in possession trusts: Income is taxed at the beneficiaries’ personal tax rates if it is distributed to them. If the income is retained by the trust, it is taxed at the trust rate. The trustees are required to report the income to HM Revenue & Customs (HMRC) and provide the beneficiary with a tax statement.
  • Bare trusts: The income is treated as the beneficiary’s income and taxed at their personal rate.

b. Tax reporting

• Trustees must file a Self-Assessment tax return for the trust, even if no tax is due, and provide details of the income and how it is distributed.

2. Capital gains tax

a. Trusts and CGT

• Trusts are subject to Capital Gains Tax (CGT) on any gains they make from the disposal of assets. The rates are:
  • Discretionary trusts: Gains are taxed at 20% (or 28% for gains on residential property).
  • Interest in possession trusts: Gains are also taxed at the same rates as discretionary trusts.
  • Bare trusts: The gains are treated as belonging to the beneficiary, who pays CGT at their personal rate.

b. Reporting and payment

• Trustees must report capital gains and pay any tax due within the specified deadlines. There are complicated rules about reliefs and exemptions and the calculation of chargeable gains. You should seek professional advice on this matter.

c. Annual exemption

• Trusts have a separate annual exempt amount for CGT, which is lower than that for individuals. As of the 2023/24 tax year, the annual exempt amount for trusts is £6,000, compared to £12,300 for individuals.

3. Inheritance tax (IHT)

a. IHT on trusts

• Inheritance tax is a significant consideration for trusts, particularly on the transfer of assets into the trust and on distributions.
  • Nil rate band: Transfers into most types of trusts are subject to IHT if the value exceeds the nil rate band (£325,000 for the 2023/24 tax year).
  • Lifetime transfers: Transfers into a trust may be subject to immediate IHT if they exceed the nil rate band or if the trust is not exempt (e.g., a gift to a charitable trust is exempt).
  • Ten-year charge: Discretionary trusts are subject to a ten-year anniversary charge, where IHT is payable on the value of the trust assets over the nil rate band.
  • Exit charge: When assets are distributed from a discretionary trust, an exit charge may apply based on their value and the length of time in the trust.

b. Reporting and payment

• Trustees must file an IHT return if:
  •  The trust’s value exceeds the threshold on 10-year anniversaries
  •  If the trust comes to an end
  • If assets are transferred out of the trust — unless the trust is an excepted trust). 

The trustees must pay any IHT due. This is generally done by completing an Inheritance Tax form (IHT100) and sending it to HMRC.

There’s no denying this information is pretty overwhelming, but a solicitor can help you manage your trust fund and explain what you need to do when paying taxes. This is just a general overview and there are points of detail we have not included. 

You must get tax advice specific to your circumstances and your particular trust before you act or decide not to act.

For more information, read our Inheritance Tax Planning Guide.

What should I do if I need help to set up or manage a trust fund?

At Burt Brill & Cardens, we are specialists in the law regarding trusts and trust funds. We represent beneficiaries, settlors and trustees in dealing with trusts, providing legal advice and representation on a wide range of issues.

We will be happy to answer your queries on how to set up a trust. give you advice and guidance on managing your trust and connect you with solicitors with the expertise to help. More information is also available on our webpage, Setting up a Trust.

To speak to one of our expert trust solicitors, ring us on 01273 604 123, email us at enquire@bbc-law.co.uk or make an enquiry.