Trusts, a way of arranging property for the benefit of others, while still maintaining some control over it
This is a brief guide to the different types of trust available and the terminology used around trusts. It focuses on trusts established under the law of England and Wales. Different principles and terminology can apply for trusts established under Scottish law – we will deal with these in a future blog. Professional advice should be sought before establishing a trust to ensure that it meets your needs and objectives. Once established, some trusts can be very difficult to unwind.
Absolute trust: A trust where the beneficiaries are named at outset, as are their shares of the trust fund, and it is not possible to subsequently amend the arrangement. The beneficiaries are absolutely entitled to the trust assets, which means that when they reach the age of 18, they can demand their share from the trustees who will not be in a position to refuse.
Accumulation and Maintenance (A&M) trust: An A&M trust was a special type of discretionary trust set up before 22 March 2006. An A&M trust provided that a beneficiary will become entitled to their share of the trust capital on attaining a specified age being not more than 25. However, this type of arrangement has specific provisions to allow the trustees to accumulate the income arising on the trust assets within the trust for the future support of the beneficiaries, instead of having to pay the income out to the beneficiaries as it arises. A&M trusts are now treated as relevant property trusts unless an A&M trust created before 22 March 2006 was amended before 6 April 2008 to give the beneficiary an entitlement to capital by age 18.
Appointment beneficiary (also known as the “wider class” beneficiaries): The people who may benefit from a trust fund but only if and when the trustees so choose. Where this is the case the trustees must decide how much of the trust fund they wish to transfer to the beneficiary in question and then they must actually “appoint” the amount or the asset to that person. If no such appointment is made during the life of the trust then the appointment beneficiary will gain no benefit from the arrangement.
Bare trust: See absolute trust.
Beneficiary: The person(s) or class(es) of persons who has been nominated by the donor/ settlor to benefit or potentially benefit from the arrangement.
Bypass trust: A discretionary trust which is typically used to accept pension and death-in-service scheme death benefits to prevent them forming part of the estate of, say, a surviving spouse. Beneficiaries would typically include a surviving spouse and children.
Chargeable (lifetime) transfer: A transfer of assets that is immediately liable to inheritance tax. The most common chargeable lifetime transfers are gifts to trusts (apart from gifts to bare trusts). Chargeable lifetime transfers are charged at one-half of the death rate for inheritance tax on the excess over an individual’s available nil rate band. If death occurs within seven years of the transfer, an additional liability to inheritance tax at the death rate may arise (although this may be reduced by the application of tapering relief).
Charitable trust: Charitable trusts are administered and supervised by the Charities Commission. A [permanent] charitable trust must be registered with the Charity Commissioners and will only be deemed to be such a trust if it is for certain specific circumstances including relief of poverty, promotion of religion or education or other purposes of benefit to the community. Charitable trusts enjoy substantial tax privileges and can be set up in perpetuity.
Class of beneficiary: A group of unnamed beneficiaries who could potentially benefit under a discretionary or flexible trust. ‘My children and further issue’ as a class would include all children and their issue who are alive during the trust period (but not necessarily born at the time the trust is created).
Complex estate: An estate that is worth more than £2.5 million at the date of death and/ or where the value of assets sold in a tax year by the personal representatives is more than £500,000 (£250,000 if death occurred before 6 April 2016) and/ or incurs total income tax and/ or capital gains tax liabilities of £10,000 during the period of administration.
Constructive trust: A constructive trust would be imposed, irrespective of any intention, where it would be unjust for the holder of the property to hold it for his or her own benefit, or in situations, for example, where a trustee is profiting from a trust created for the benefit of others.
Contingent trust: An arrangement where the beneficiary will only gain an entitlement to his or her share of the trust fund on the happening of a certain event (e.g. on reaching a certain age or in the event of getting married).
Default beneficiary (also known as the remaindermen): The individuals who are intended to benefit from the trust fund when the trust comes to an end or in default of appointment of trust assets to other beneficiaries. However, their entitlement at that time cannot be guaranteed in advance because the trustees have the power to re-direct trust assets during a specified time limit to the appointment beneficiaries (see above) where they feel this is appropriate. Here it is important to note that a default beneficiary will also be included in the wider class as an appointment beneficiary.
Disabled person’s trust: A trust that is are established for a disabled person that offers inheritance tax and capital gains tax advantages. In order to qualify for these tax advantages, the trust has to meet certain conditions.
Discounted gift trust: A discounted gift trust is an inheritance tax planning tool that allows the settlor to maintain access to a proportion of the amount gifted into the trust through a stream of regular payments. The value of this stream of payments (the discount) is deemed to remain within the settlor’s estate, whilst the balance represents the taxable value of the gift to the trust for inheritance tax purposes.
Discretionary trust: An arrangement where no beneficiary has an interest in possession. The trustees have the discretion to appoint income and capital from the trust to any beneficiary who falls within the stated class(es) of beneficiary. Unless the trustees make an appointment in favour of a beneficiary, that beneficiary has no entitlement to the trust’s assets.
Donor: See settlor.
Excluded trust: A trust that is not required to be registered on the Trust Registration Service at a point in time. A trust that has been excluded may need to be registered at a later date.
Express trust: A trust that has been deliberately created by the settlor, usually by executing a written deed.
Flexible trust: A trust where flexibility is provided with regard to who the beneficiaries are and what their shares of the trust fund should be. This flexibility is provided through there being two classes of beneficiary, one of which (the default beneficiaries) will gain the benefit of the trust fund so long as the trustees do not choose to transfer their share to a beneficiary of the other class (the appointment beneficiaries).
Gift & loan trust: See loan trust.
Gift with reservation: A principle which arises when an individual transfers assets either to another person or to a trust by way of a gift but maintains an interest or benefit in that asset. Where this is the case for inheritance tax purposes, it is deemed the individual has made a “gift with reservation” and the value of that gift plus all capital growth on it will be deemed to form part of his or her estate on death.
Immediate post-death interest (IPDI) trust: An IPDI trust is not a relevant property trust. To qualify as an IPDI trust, assets must pass into the trust on an individual’s death, either through the terms of the will or through intestacy. At least one beneficiary has an immediate interest in possession (the life tenant). On the life tenant’s subsequent death, the trust assets will typically pass to the remaindermen.
Implied and resulting trust: The law will imply that a trust exists (even if a trust was not actually created) where it considers that the intention was to create such a trust. Most implied trusts are also resulting trusts in that the beneficial interest in the trust funds goes back, or results back, to the settlor.
Inheritance tax: A tax that is payable both on death, based on the value of an individual’s assets, and during lifetime if the individual passes assets out of his or her estate. Certain allowances and exemptions apply that reduce the amount of any inheritance tax that may become payable.
Interest in possession trust: A trust where a specified beneficiary (the life tenant) has a right to the income being generated from the trust fund, regardless of whether any income is actually generated. An interest in possession does not give a right to receive the trust capital although some trust deeds will also allow the trustees to appoint capital to the life tenant. On the life tenant’s death, the capital passes to the remaindermen (default beneficiaries).
Intestacy: If an individual dies without a valid will, he or she is deemed to have died intestate and the destination of the estate is determined by law.
Loan Trust: Loan trusts are inheritance tax mitigation tools. Such arrangements have the ability to “freeze” the value of a portion of the settlor’s estate for inheritance tax purposes, whilst allowing the settlor access to the original capital invested.
Married Women’s Property Act 1882 (MWPA): The MWPA is an example of a statutory trust. Assets held by a trust written under the MWPA are protected from HM Revenue & Customs and creditors.
Non-statutory trust: A trust that is not specifically established by a statute.
Periodic charge: A periodic charge may arise on a relevant property trust (but not an absolute trust, IPDI trust, bereaved minors trust or 18-25 trust) on each 10-year anniversary of its creation. The calculation of periodic charges is complicated but, broadly, it is calculated as 6% of the notional value of the trust immediately before the 10-year anniversary. The trustees are responsible for accounting for periodic charges to HMRC using form IHT100.
Pilot trust: A trust which is established with a nominal amount (say, £10) which can then accept further assets in the future.
Potential beneficiaries: Named beneficiaries and/ or classes of beneficiaries who can potentially benefit under a discretionary or flexible trust. A potential beneficiary has no rights under the trust until such a time that the trustees appoint benefits to him or her.
Potentially Exempt Transfer (PET): A transfer of assets to an individual or a bare trust (not a discretionary trust). Where such a transfer is made there is no immediate charge to inheritance tax, but there is a potential charge to the tax if the person who made the transfer (the donor) dies within seven years of making the gift. On death within seven years, the value of the gift at the date of transfer is added back into the estate of the donor to calculate any inheritance tax liability (although tapering relief may apply). If the donor dies seven or more years after making the PET, the value of the gift falls outside of the donor’s estate for inheritance tax purposes (i.e. it becomes exempt).
Power of appointment trust: A trust where there are some beneficiaries who do not have an interest in possession and their entitlement depends on appointment, by the trustees, during the lifetime of the trust. Both flexible trusts and discretionary trusts are power of appointment trusts.
Probate trust: A probate trust (also known as an asset or estate protection trust) is typically a discretionary trust and could be used to act as a wrapper to hold UK or offshore assets with the intention to avoid these assets falling into UK or foreign probate in the event of the death of the settlor, thereby allowing speedy transfer of these assets to beneficiaries and avoiding unnecessary costs and delays. The settlor may be a beneficiary of a probate trust and may therefore maintain full access to the asset. In such cases a probate trust is likely to be ineffective for inheritance tax purposes but prevents the assets held in the trust being subject to probate on the settlor’s death.
Protective trust: A protective trust would be created on the life of a principal beneficiary, and would last throughout his or her lifetime, unless a particular event (such as bankruptcy or a criminal conviction) occurred to deprive him or her of this income. In this event the trust would revert to a discretionary trust for the benefit of a wider class of beneficiaries such as the principal beneficiary’s spouse and children.
Relevant property trusts: Relevant property trusts include discretionary trusts, accumulation and maintenance trusts and most interest in possession trusts. The assets held in a relevant property trust do not generally form part of a beneficiary’s estate on his or her death.
Remaindermen: See default beneficiary.
Settlor: this is the person who will set up the arrangement and will also be the person providing the money or property that is to be held within the trust.
Simple trust: See absolute trust.
Statutory trust: Statutory trusts are trusts established by a statute (such as the Married Women’s Property Act 1882). Other examples where a statutory trust may be established include assets being passed to minor beneficiaries under a will or through intestacy. Statutory trusts, by their nature, are generally less flexible than non-statutory trusts, but may provide greater protection of the trust assets from creditors and/ or HMRC.
Tapering relief: A device that reduces the actual rate of inheritance tax that may be payable on transfers (whether chargeable transfers or potentially exempt transfers) should the transferor die within seven years of the date of transfer. The percentage of the rate of inheritance tax is charged as follows: Death within 0 – 3 years of transfer 100%, 3-4 years 80%, 4-5 years 60%, 5-6 years 40%, 6-7 years 20%, over 7 years 0%.
Trust: An arrangement by which a person (the donor/ settlor) gives assets to certain trusted people (the trustees) who are under a duty to hold and administer that property for the benefit of people, or a class of people (the beneficiaries), as chosen by the donor/ settlor.
Trust deed: The instrument that establishes the trust.
Trustees: The people who administer the trust arrangement and thus legally own and control the property of the trust. The trustees control this property for the benefit of others, these others being the beneficiaries.
Trust for a bereaved minor: A trust for a bereaved minor can only be set up on the death of a parent (including a step-parent) for a minor child. A trust for a bereaved minor gives the beneficiary the absolute entitlement to the trust’s assets at the age of 18. When a parent dies intestate, a trust for a bereaved minor is always created.
18-25 trusts: Under an 18-25 trust, the beneficiary must become entitled to the trust assets not later than the age of 25. 18-25 trusts are exempted from the discretionary trust tax regime on any payments out before the beneficiary attains the age of 18. No entry or periodic charges to inheritance tax apply to 18-25 trusts although an exit charge may apply if the beneficiary becomes absolutely entitled to the trust assets after attaining the age of 18.
Trust Registration Service (TRS): A central register of trusts administered by HMRC as an anti-money laundering, anti-financing of terrorism initiative. Since 1 September 2022, most express trusts are now required to be registered on the TRS.
Will trust: A will trust is a trust that is created on an individual’s death through their will. Will trusts can include bare trusts, interest in possession trusts, contingent trusts and discretionary trusts.
Trustee Support Services can register trusts on the Trust Registration Service on behalf of trustees. We also provide a range of other services to assist trustees in the day-to-day running of their trusts. Please contact us for further details.
