In the Beginning
Trusts developed out of the need for English mediaeval landowners to leave someone in charge of their lands for years whilst they went crusading, trusting that it would be returned to them intact when they returned or passed to their heirs if they did not. This act of trust came to be recognised and enforceable through the law courts as a Trust and gave rise to the branch of English law known as equity.
What is a Trust?
A modern Trust is not very dissimilar from its medieval form. The basic arrangement is a private legal agreement whereby one legal person (the Settlor) transfers some assets (usually property or cash) to a Trust Fund managed by another legal person, group of individuals or a trust company (the Trustees) to look after and use to benefit a third person or group of people (the Beneficiary/ies). The details of the Trust should be set out in a Trust Deed and it is worth noting that a Settlor can also be a Trustee and indeed a Beneficiary, but when acting as a Trustee he must put the interests of the Beneficiary before those of the Settlor.
Trusts Give Control
Trusts allow wealthy Settlors to control the destination of their money not just throughout their lifetime but also after they have died. Trusts are particularly important to Settlors who care for minors, the elderly, the disabled, the long term sick and other vulnerable persons who cannot manage their own money and want to provide for them after they themselves have gone.
Who Owns the Assets in the Trust Fund?
Although the assets are put into a Trust Fund, the assets in the Trust Fund are not legally owned by the Trust. The Trustees themselves are the legal owners of the assets and the Beneficiaries are the beneficial owners of the assets. The Trustees are therefore personally liable to the Beneficiaries for the assets and income of the Trust Fund and to the tax man for taxes due from the Trust Fund, something they might not always be aware of.
Where there’s Trusts
Trusts are still play a key role in many aspects of modern life. For most people the types of Trust they are most likely to be encounter have been set up to manage their family’s financial affairs, their pension funds, their life insurance and assurance policies and charities.
Keeping it in the Family
Some of the most common family situations where trusts are used (often in a will) are:
• To provide for a spouse or civil partner after death while protecting the interests of any children from that relationship or an earlier one
• To protect the inheritance of young children until they are old enough to take responsibility for their own efforts
• To provide for disabled or vulnerable relatives who are unable to look after their own affairs
• To control who will participate and on what basis in the family business.
Company Pension Schemes
Most company pension schemes are structured as trusts, with the employer (who in this case is the Settlor) giving cash to a pension fund manager (the trustee) to invest for the benefit of employees when they retire (the beneficiaries). The trust structure helps clarify the administration, regulation and taxation of the pension fund.
That’s Life Insurance
Similarly, many life insurance policies are “written in trust” so that when the person insured dies the policy pays out to a trust run by the insurer, which then pays the cash out in line with the insured person’s wishes. The trust structure both helps minimise inheritance taxes (see more on this in the section on trusts and taxes) and ensures that the deceased’s wishes about how the insurance funds are to be distributed can be followed quickly and accurately.
Trusts are also very commonly used for charitable funding to provide funds for research, education, animal welfare or poverty relief.
Do Trusts Avoid Taxes?
Trusts are often represented in the media as vehicles to avoid tax. In reality, there are few circumstances in which anyone would be well-advised to set up a Trust just to gain tax advantages. In setting up a Trust, the Settlor is giving up ownership of the assets in the Trust. Such a dramatic decision only makes sense if the Settlor has clear objectives that they wish to achieve with those assets, and tax is likely to be an important but still secondary issue.
The tax advantages given to Trusts are now largely limited to Trusts that provide a social benefit. Charitable Trusts are an obvious example, but Trusts set up to look after minors and vulnerable or disabled relatives continue to attract some tax advantages.
The Raid on Trusts
Most other Trusts attract relatively few tax advantages. HMRC’s official position is to pursue a policy of being tax neutral towards trusts so that the tax system neither encourages nor discourages anyone from setting one up, but since the 2006 Budget, almost universally described as ‘the raid on trusts’, it is hard not to take the view that HMRC now actively (and successfully) discourages the creation of family trusts.
Into the Future
Tax breaks will rarely be the main reason for setting up a Trust. The key attractions are, instead, the ability of Trusts to ensure that assets will ultimately be used in a certain way while allowing flexibility in how those assets are managed before they are distributed. If you like, you are entrusting someone to deliver a brand new Ferrari to Timbuktu by a certain date with minimal damage, but leaving the details of how they do it to them.