What types of trust are there?
There are several main types of trust, and they are treated in different ways for Inheritance Tax (IHT) purposes:
|Type of trust||What is it?||How does IHT apply to this type of trust?|
|Bare trust||This means that the trust is held in the name of a trustee, but the beneficiary is absolutely entitled to everything in the trust (capital plus any income it generates). They can take possession of these assets at any time, providing they’re 18 or over, and of sound mind.||
If you transfer assets into a bare trust during your lifetime and you survive for another 7 years after making that transfer, then that transfer amount is exempt from IHT, because it’s no longer counted as part of your estate.
If you make transfers into a bare trust and die within 7 years of that date, the value of these transfers will be added to your estate for IHT purposes.
|Interest in possession trusts||This is where the beneficiary receives income from the assets (such as interest from shares or rental income from a house that’s rented out) as it arises, but can’t touch the raw capital that generates the income. It can also mean enjoying a benefit such as a surviving spouse continuing to live in the family home rent-free, but the asset still passing to any children on that spouse’s death.||
If gifts/transfers were made during your lifetime and they were transferred into the trust on or after 23 March 2006, then a 10-yearly IHT may be payable, along with an exit charge (exit charges are currently up to 6% on those assets that are ‘relevant property’ such as land, buildings and money).
The beneficiary will need to pay income tax on any income they receive from the trust, according to their own individual tax band.
|Discretionary trusts||The trustees have full discretionary powers on managing the trust, including distribution to beneficiaries of the assets and income.||The initial transfer is a ‘chargeable lifetime transfer’. If that initial transfer exceeds the IHT nil-rate band available to the settlor then IHT will be payable immediately at the ‘lifetime rate’ – that is, 20% to pay at the time of transfer. If the settlor dies within 7 years of the transfer, a further 20% is then payable as IHT at the time of death.|
|Trusts for bereaved minors||This is a trust set up by a parent solely for the benefit of their own child (or step-child) under 18 upon the parent’s death. It must be distinct from a ‘gift’ left in a will, which doesn’t have an age restriction on it, or a gift that’s to be payable at a later age. A bereaved minor trust is subject to the child fully inheriting when (or before) they turn 18.||
If your child is aged under 18 at the time of your death and becomes entitled to the assets of a gift/trust in a will upon (or before) reaching 18, there won’t be any immediate IHT charge either at the time of death or on the child reaching 18. Providing the child becomes fully entitled to both the capital and the income in the trust before this age, there is also no 10-yearly charge nor exit charge when the assets leave the trust.
The results are more complex if you want your child to inherit between the ages of 18 and 25, which creates an ’18-25 trust’. There would be an exit charge for this kind of trust, and a proportion of IHT may be payable if the trust value exceeded the nil rate band of £325,000.
How can trusts be used in a will?
Trusts have many useful applications – the 3 most common are listed below.
1. Leaving assets to young children
You can set up a trust that states that the assets (the trust fund) are managed by the trustees until your child or children reach a specified age at which they’re entitled to receive the trust fund.
Your will can state that during the interim period the trust fund is made available for the benefit of your children on a controlled basis.
For example, if a couple die and leave children, their assets can be placed in trust until the children reach 21, but their guardians would be able to access some of the funds, if needed, to ensure a comfortable upbringing for the children. In this way the trustees retain control of the assets and can ensure that they are used only for the benefit of the children.
These types of trusts are also popular with grandparents wanting to leave assets to young grandchildren
2. Second marriages
If you’ve remarried, but have children from a first marriage, you can set up a trust so that if you (the testator) die, your surviving spouse receives a ‘life interest’ in the marital home: meaning that he or she can live in it rent free until they die or remarry.
When your surviving spouse then dies, the house passes to your children. In this way, you determine the ultimate destination of the property, whilst still letting your spouse retain the benefit during their lifetime.
3. Minimising inheritance tax
You can set up a nil rate band discretionary trust to help minimise the amount of Inheritance Tax payable out of your estate. Please see our Inheritance Tax pages for further information.
Trusts have many more applications that the common ones listed, and trust law is very complex. Our wills and probate experts offer specialist advice to help you decide which type may be appropriate to your personal circumstances. We also explain any possible tax implications.
Please contact us for a free, no obligation consultation where we will be happy to discuss your particular needs.