Trusts Explained: A Plain-English Guide to How Trusts Work in England and Wales

What Is a Trust?

A trust is a legal arrangement. One person (the "settlor") transfers assets to one or more people (the "trustees") to hold and manage for the benefit of others (the "beneficiaries").

The key idea is that legal ownership is separated from benefit. The trustees own the assets in law, but not for themselves. They hold them for the beneficiaries and must manage them according to the terms of the trust and the law.

The People Involved

The settlor. The person who creates the trust and puts assets into it. For a trust created by a will, the settlor is the person who has died.

The trustees. The people who manage the trust assets. Trustees must act in the beneficiaries' best interests, act impartially and follow the terms of the trust. Trustees can be family members, friends or professionals such as solicitors or accountants.

The beneficiaries. The people who benefit. Depending on the type of trust, a beneficiary may have a fixed right to income or capital, or may be one of a wider group whom the trustees can choose to benefit.

Common Types of Trust

Bare trusts (or simple trusts). The trustees hold assets for a named beneficiary who has an absolute right to the capital and the income. Once the beneficiary is 18, they can demand the assets. Bare trusts are often used to hold assets for children.

Life interest trusts (interest in possession trusts). A named beneficiary (the "life tenant") has the right to the income from the trust assets, or the right to use an asset (such as living in a property), for their lifetime. When the life tenant dies, the capital passes to other named beneficiaries. Couples often use them to protect assets for children from a previous relationship.

Discretionary trusts. The trustees decide how to distribute income and capital among a defined group of beneficiaries. No beneficiary has a right to anything. The trustees decide who benefits, when and how much. This flexibility makes discretionary trusts useful for protecting assets from a beneficiary's divorce, bankruptcy or poor money management.

Disabled person's trusts. Trusts set up for someone who is disabled, with favourable tax treatment.

Accumulation and maintenance trusts. Trusts designed to build up assets for beneficiaries, often children, over time.

Lifetime Trusts and Will Trusts

Lifetime trusts are set up during the settlor's lifetime by signing a trust deed and transferring assets into the trust. They take effect at once and can have immediate tax consequences.

Will trusts are created by the terms of a will and only take effect when the person dies. Common examples are a life interest trust for a surviving spouse and a discretionary trust for children.

What Trusts Are Used For

Trusts serve many legitimate purposes: protecting assets for future generations, providing for vulnerable beneficiaries, inheritance tax planning, preventing sideways inheritance and, with important caveats, protecting against care home fee assessments.

On the last point, a local authority can treat a transfer into a trust as "deliberate deprivation of assets" if the main purpose was to reduce your assets for means-testing. Any trust must be set up for genuine estate planning reasons.

The Tax Position of Trusts

Trusts have their own tax rules. Transfers into most trusts are "chargeable lifetime transfers". If the total exceeds the nil-rate band of £325,000, there may be an immediate inheritance tax charge of 20%. Trusts also pay a periodic charge (up to 6%) every ten years and exit charges when capital is paid out. Income tax and capital gains tax apply at special trust rates.

Registration Requirements

Since 2022, most trusts must be registered with HMRC's Trust Registration Service (TRS). Failing to register can lead to penalties.

A Word of Caution

Trusts are powerful, but they are not a magic solution. A badly structured trust can create more problems than it solves. Some trusts have been mis-sold, particularly so-called "asset protection trusts" marketed as a way to avoid care home fees or inheritance tax.

Any trust should be set up with clear aims and advice from a suitably qualified solicitor.

If you are considering a trust, contact Aaron. He is a solicitor and a TEP (a full member of STEP, the Society of Trust and Estate Practitioners) and can advise on the full range of options.

This guide is general information, not legal advice.